Bank of Boroda Rajib

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 1

Objectives of the project: To assess the suitability of the company for disbursement of credit. This would involve the following actions: Use of credit rating charts Evaluation of management risk Evaluation of financial risk Evaluation of market-industry risk Evaluation of the facility Evaluation of compliance of sanction terms Calculation of credit rating

Determination of interest rate: This would entail the following sequence of actions. Collect data regarding financial health evaluation Noting down of credit rating Referencing the banks’ interest rate guidelines circular Choosing the interest rate from the circular on the basis of financial health and credit rating

To assess the financial health of organizations that approaches Bank of Baroda for credit for business purposes. This would entail undertaking of the following procedures:

Analysis of past and present financial statements Analysis of Balance Sheet Analysis of Cash Flow Statements Examination of Profitability statements Examination of projected financial statements Examination of CMA data

International business school, Kolkata

Bank of Baroda

Bank of Baroda International business school, Kolkata

Credit Appraisal & Credit Rating Priority of credit appraisal Stages of credit analysis and rating Evaluation of credit rating India’s credit rating agencies SEBI’s regulations Basis of credit appraisal methodology Risk management Different types of risk Need of sound credit appraisal and accurate risk assessment

INTRODUCTION

CHAPTER - I ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 2

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 3

Credit Appraisal & Credit Rating A credit rating is an assessment by a third party of the creditworthiness of an issuer of financial securities. It tells investors the likelihood of default, or non-payment, by the issuer of its financial obligations. Credit analysis is the financial analysis used to determine the creditworthiness of an issuer. It examines the capability of a borrower, or issuer of financial obligations, to repay the amounts owing on schedule or at all. Credit rating is a tool in the hands of financial intermediaries, such as banks and financial institutions that can be effectively employed for taking decisions relating to lending and investments. Credit rating is the assessment of a borrower’s credit quality. Credit ratings performs the function of credit risk evaluation reflecting the borrower’s expected capability to repay the debt as per terms of issue. Credit rating establishes a link between risk and return. An investor or any other interested person uses the rating to assess the risk level and compares the offered rate of return with his expected rate of return. Establishing the creditworthiness of borrowers is one of the oldest established financial activities known. Through history, the act of lending funds has been accompanied by an examination of the ability of the borrower to repay the funds. The most ancient civilizations and societies known to us often show development of sophisticated trading and banking activities. As modern accounting and finance developed during the industrial revolution, banking and lending grew to a larger scale and became more systematic. The analysis of the creditworthiness involves preliminary study of the factors and pre-requisites which can affect adversely the duly repayment of the credit. It is of high importance that bank specialists demonstrate competence and conscientiousness. Banks have at their disposal various ways for choosing suitable borrowers to be financed and for exercising control over the special purpose of the credit resources and their expedient

International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 4

and efficient spending. Today Banks and NBFC’s use their own credit rating techniques as credit rating agencies usually done, for appraisal of credit worthiness of borrowers and assessment of total risk.

Borrower rating (individual & corporate) Bond Equit Short Credit Ratin Term y Rating Ratin instrum g ents g rating

The priority of the credit analysis is to determine the following: The managerial qualities of the loan applicant > His ability to regularly repay the loan, the interest accrued and charges by using his current revenue from his business activity at present and in the future >The amount of his capital and the possibility to use it to secure the borrowing of the commercial bank-creditor in the event of risky situations >The influence of micro and macro environment over the business activity of the company during the current period and in the future and respectively over his ability to service the bank loan >Specific risk situations which can affect the borrower's money inflow and consequently result in problems with the repayment of the loan >The correspondence between the extended credit and the real need for it >The correspondence between the term of credit and the circulation speed of the funds for the raising of which it was extended.

Traditional Approach: International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 5

There are five criteria (5 C Analysis) that most lenders use to assess a borrower’s creditworthiness: capacity to generate sufficient cash flows to service the loan; collateral to secure the loan in case the borrower defaults; capital that shareholders have invested in the business; conditions prevailing in the borrower’s industry and broader economy; and character and track record of the borrower and the borrower’s management

The stages of the credit analysis are as follows: Credit Rating is not: >General purpose evaluation of issuer >Audit of the issuing company >onetime assessment of credit worthiness of the issuer valid over the future life of the security.

Evaluation of Credit Rating This concept originated in the US in 1909 AD when the founder of Moody’s Investor Service, John Moody, rated the US Rail Road Bonds. However, the relevance of this concept was realized only after the great depression when investors lost all their money. lack of symmetric information and high costs of collecting information increased the popularity of credit rating. The world’s biggest rating agencies are Moody’s investor service and Standard and Poor’s(S&P).They have been into the rating business for decades(since 1916).The rating giants have diversified their service portfolio in order to survive and grow. Besides rating bond issues – their core rating business-they have diversified into rating asset backed securities, commercial papers, bank loans, and other financial products.

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 6

The growth of credit rating industry in India (External Rating Agencies) India was the first among the developing world to set up a credit rating agency-Credit Rating Information Services of India Ltd. (CRISIL) in 1988.Then came ICRA(Investment Information and Credit Rating Agency of India Ltd.) in 1990,followed by CARE( Credit analysis and Research Ltd.) in 1993.Another one is Fitch Rating India Private Ltd. Was formerly known as OCR India –Duff and Phelps Credit Rating Co. USA and OCR India merged to form a new entity called Fitch India. Fitch is the only international rating agency with a presence on the ground in India. The credit rating function was further institutionalized in the 1990s when the RBI and SEBI made credit rating mandatory for the issue of Commercial Paper (CP) and certain categories of debentures and debt instruments. Example of CRISIL credit rating given below:

ICRA Credit rating: CP=Commercial paper A1 Highest safety A2 High safety A3 Adequate safety A4 Risk Prone

Fully/partly/non-convertible debenture LAAA Highest safety LAA High safety LA Adequate safety LBBB Moderate safety LBB Inadequate safety

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Certificate of deposit/FD MAAA Highest safety MAA High safety MA Adequate safety MB Inadequate safety MC Risk prone

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 7 LB Risk prone LC Substantial Risk LD Default

CARE credit rating: PR1 – Superior, PR2 – Strong, PR3 – Adequate, PR4 – Risk prone, PR5- Default CARE AAA - Best quality (high investment grade), CARE AA-High quality, CARE A-Adequate Safety, CARE BBB-Moderate safety, CARE BB- Inadequate safety, CARE B- Risk prone, CARE C-High Risk, and CARE D- Default.

SEBI Regulations for Credit Rating Agencies These regulations are called the Securities and Exchange Board of India (Credit Rating Agencies) Regulations, 1999. Only commercial Banks, public financial institutions, foreign banks operating in India, foreign credit rating agencies and companies with a minimum net worth of `.100 crore as per its audited annual accounts for the previous 5 years are eligible to promote rating agencies in India. Rating agencies required to have a minimum net worth of `.5 crore. Rating agencies cannot assess financial instruments of their promoters who have more than 10% stake in them. Rating agencies cannot rate a security issued by an entity which is a borrower of its promoter or a subsidiary of its promoter or an associate of its promoter. Rating agencies cannot rate a security issued by its associate or subsidiary,if the credit rating agency or the rating committee .

Basis of Credit Appraisal Methodology: Appraisal of credit worthiness and rating are based on an indepth study of the industry and an evaluation of the strengths and weakness of the company.The analytical framework for rating consists of the following four broad areas. International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 8

Risk Management Definition of Risk: The Basel committee has defined the risk as “the probability of the unexpected happening-the probability of suffering loss”. Risk is a probability of loss, may be direct or indirect. Direct loss may be relating to loss of capital or earnings whereas indirect loss may be loss of business. Banks often distinguish between expected loss and unexpected loss. Expected losses are those that the bank knows with reasonable certainty will occur (e.g., the expected default rate of corporate loan portfolio or credit card portfolio) and are typically reserved for in some manner. Unexpected losses are those associated with unforeseen events (e.g. losses experienced by banks in the aftermath of nuclear tests, Losses due to a sudden down turn in economy or falling interest rates). Banks rely on their capital as a buffer to absorb such losses. The four letter ‘Risk’ indicates that risk is an unexpected event or incident, which needs to be identified, measures monitored and control. R = Rare (Unexpected) I = Incident (Outcome) International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 9

S = Selection (Identification) K = Knocking (measuring, monitoring, controlling) Thus, the risk management is a sum of (1) Risk identification (2) Risk measurement (3) Risk monitoring and (4) Risk control with a view to maximize Risk Adjusted on Capital Employed = (RAROCE). During the about last five years period the subject of risk management in banks is gaining momentum with Basel Committee on Banking Supervision and the Reserve Bank of India prescribing guidelines for implementation of Risk Management System by banks. While the risk management has a number of potential benefits, it does raise a number of conceptual and practical challenges. The effectiveness of implementation of the Risk Management System in different categories of banks operating in India differs from each other because banks are designing their risk management system keeping in view their own requirements dictated by size and complexity of business, risk philosophy, market perception and the expected level of capital. The Basel Committee on Banking Supervision is in the process of implementation of New Capital Accord in near future, which requires substantial up gradation of the existing Risk Management Systems in banks. The New Accord will have inbuilt provision for capital incentives for banks having advanced risk management systems and it is imperative on banks to gradually improve their systems by removing the veil of secrecy. My project mainly on Credit risk Management and Credit Worthiness/Appraisal. Credit risk is defined as the possibility of losses associated with diminution in the credit quality of borrowers or counter parties. In a bank’s portfolio, losses stem from outright default due to inability or unwillingness of a customer or counter party to meet commitments in relation to lending, trading, settlement and other financial transactions. In the backdrop, it is imperative that banks have a robust credit risk management system, which is sensitive and responsive to credit risk factors. Credit risk can be understood as the uncertainty associated with borrower’s loan repayments. Credit Risk Management encompasses identification, measurement, monitoring and control of the credit risk exposures.

Risk management process: (proposed Risk Management solution depicted in diagram)

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 10

Capital Derivative ta External Dedicated Repository Banking Operational Banks Risk data(Rating CRM Dashboard Identification Measurement Mitigation (internal MIS Application riskAgency & external) Allocation Credit risk suite Module Market Risk

Different types of Risk: International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 11

1) Market Risk

2) Operational

Risk

3) Credit Risk

4) Country Risk

1) MARKET RISK can be defined as the risk of losses in and off balance sheet positions arising from adverse movement of market variables. Market risk may be relating to Liquidity Risk: Potential inability of a bank to meet its repayment obligations in a timely and cost effective manner. Mismatch of deposits and assets. Interest Rate Risk: Risk due to change in market interest rate, which might adversely affect bank’s financial position.NIM will reduce. This depends on types of assets such as fixed or floating rate, quantum etc. Interest risk of the bank is quantitatively measured by measuring the “Duration Gap” of the bank’s financial assets.

D=Duration, F=Cash flow, Y=Discount rate, t-Time Period, PV-Present Value of the Security Unit of the duration is years Duration Gap= Dollar Weighted duration of asset portfolio- Dollar Weighted duration of bank’s liabilities Duration of Asset (DA) = [[Summation of (Expected cash inflows * Time period received)]/ (1+Discount rate) ^t]] / [Summation of (Excepted cash inflows/ (1+Disount rate) ^t)] where t=1 to n Duration of Liability (DL) = [[Summation of (Expected cash outflows * Time period International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 12

received)]/ (1+Discount rate) ^t]] / [Summation of (Excepted cash outflows/ (1+Disount rate) ^t)] where t=1 to n All the above required fields (cash inflow, time period, discount rate (given by the bankers), to calculate the duration are available in the Risk Analysis engine which are populated from bank’s MIS .

Foreign exchange Risk: Risk due to upward /downward movement in exchange rate when there is open position, either spot or forward or both in an individual currency. Commodity Price Risk: The price fluctuation in commodity, which are changed to the bank as security etc. by way of hypothecation and /or pledge. Equity Price Risk: is a loss in value of the bank’s equity investments and or equity derivatives, arising out of change in equity price, price fluctuation in stock market where bank has invested fund. 2) OPERATIONAL RISK It is a risk relating to direct or indirect losses arising out of inadequate or failure of people, process, system, business, management and /or external factors. Operational Loss= Probability of loss event (PE)* Loss given that event (LGE) 3) CREDIT RISK It is a risk of potential loss arising out of inability or unwillingness of a customer or counter party to meet its commitments in relation to lending. Hedging, settlement and other financial transactions. Thus credit risk may be relating to; Direct lending: Default risk(nonpayment of installment and interest by the loanee) Off-balance sheet items: counterparty risk –Invocation of guarantee or crystallization of L/C liability for which due has been paid or denied by the counter party. Treasury operations: Forward contract obligations, credit derivatives etc. on the due date the party’s refusing/denied the payment/ delivery. Security transaction: the counter party may not effect fund settlement/ security settlement. Counter party risk: when there are two or more contracts entered into and liabilities are depending upon happening of certain events and the party on whose behalf we have taken exposure express his inability to pay out is called counter party risk. Portfolio Risk: is also called credit concentration risk, this arises due to failure of particular segment/activity where the bank is having substantial exposure. To mitigate such risk there are sectoral exposure, single/group exposure ceiling, activity ceiling etc.

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 13

Defaulter risk: there is a one contract only between bank and borrowers may be due to unwillingness or inability of the borrower.

The topics covered by me during my internship in Bank of Baroda are: Credit rating Techno-Economic Viability (TEV) report Appraisal of Term Loan and Working Capital Credit Audit NPA Management Industry Profile Domestic Loan Policy All these topics have been discussed below in details.

Credit rating Credit is considered as core business activity of the banking resulting into profit. Therefore, it is necessary to increase the credit portfolio and also to mitigate the risk relating to credit. Credit rating was the very first topic covered by me in the bank. An effective way to mitigate credit risks is to have a robust rating system in place, which can identify potential risks in a particular asset, allow a bank to maintain a healthy asset quality and at the same time impart flexibility in pricing assets to meet the required risk return parameters. A robust credit rating system enables the bank in determining the probability of default and the severity of default among its loan assets and thus allows the bank to build systems and initiate measures to maintain its asset quality. Credit risk rating is basically assigned to borrowers based on their ability or willingness to repay the debt. The rating model structure is shown below:

Bank of Baroda also has a strong credit rating system. The bank earlier used the AAIPL method i.e M/S Arthur Anderson (I) P Limited, which was the traditional method. Banks Consultants on Risk Management M/S International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 14

Arthur Anderson (I) P Limited has suggested for introducing new credit rating model i.e. CRISIL rating models, for adapting the current day techniques in credit risk management. Before introducing the CRISIL rating models for credit risk rating, I want to give a small overview on credit risk models of all commercial advances.

Overview of Four Credit Risk Models: A brief overview of the four credit risk models that have achieved global acceptance as benchmarks for measuring stand-alone as well as portfolio credit risk is given below: The four models are: Altman’s Z-Score model KMV model for measuring default risk Credit Metrics Credit Risk The first two models were developed to measure the default risk associated with an individual borrower. The ZScore model separates the ‘bad’ firms or the firms in financial distress from the set of ‘good’ firms who are able to service their debt obligations in time. The KMV model, on the other hand, estimates the default probability of each firm. Thus, the output of this model can be used as an input for risk based pricing mechanism and for allocation of economic capital. The other two models are the most frequently used portfolio risk models in credit risk literature. They are intended to measure the same risks, but impose different restrictions, make different distributional assumptions and use different techniques for calibration. Z Score Model Altman’s Z score model is an application of multivariate discriminant analysis in credit risk modeling. Discriminate analysis is a multivariate statistical technique that analyses a set of variables in order to differentiate two or more groups by minimizing the within group variance and maximizing the between group variance simultaneously. Altman started with twenty variables (Financial Ratios) and finally five of them were found to be significant. The resulting discriminate function was Z = 0.72X1 + 0.85X2 +3.1X3 + 0.42X4 +X5 Where, International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 15

X1 = Working Capital / Total Assets X2 = Retained Earnings/Total Assets X3=Earnings Before Interest And Taxes/Total Assets X4=Market Value Of Equity/Book Value Of Total Liabilities X5=Sales/Total Assets Altman found a lower bound value of 1.2 (Critical Zone and an upper bound value of 2.8(Safe Zone) to be optimal. Any score in between 1.2 and 2.9 was treated as being in the gray zone.

KMV Model KMV Corporation has built a credit risk model that uses information on stock prices and the capital structure of the firm to estimate its default probability. The starting point of this model is the proposition that a firm will default only if its asset value falls below a certain level (Default Point), which is a function of its liability. It estimates the asset value of the firm and its asset volatility from the market value of equity and the debt structure in the option theoretic framework. Using these two values, a metric (Distance from default or DD) is constructed that represents the number of standard deviation i.e the number of times the firm’s assets value is away from the default point.. However, this method was successfully commercialized by Moody’s KMV (formerly KMV Corporation). Finally, a mapping is done between the DD value and the actual default rate, based on the historical experience. The result probability is called Expected Default Frequency (EDF). Moody’s KMV uses this theoretical framework to predict default and arrive at the expected default frequency (EDF) of the firms. The starting point of the analysis is the proposition that when the value of a firm’s assets falls below a threshold level, the firm defaults. The EDF is found through the following steps: • The market value of the assets and the volatility of the assets are derived using option pricing formulae with the market value of the equity, the book value of the liabilities, and the volatility of the stock as input parameters. • The expected value of the assets at the horizon and the default point are determined from the firm’s current value of the assets and the firm’s liability, respectively. • Using the expected firm value, the default point and the asset volatility, the percentage drop in the firm value is determined, which would bring the firm to the default point. The number of standard deviations that the asset International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 16

value drops to reach the default point is called the distance to default. However, the distance to default is a normalized ordinal measure of the default likelihood similar to the bond rating. KMV determines the expected default frequency, which is a cardinal measure, by mapping the ‘distance to default’ to the ‘default rate’, based on the historical experience of organizations with different ‘distance to default’ values. It is important to note that the fundamental assumption behind this method is that the market values contain all the relevant information about the factors, which determine the default probability. That is why no explicit recognition is given to the differentiating factors like industry, size and economy. Another important thing to note regarding this approach is that it is not a directly predictive approach unlike most other default prediction models. There is no separate forecasting algorithm ingrained within the methodology. The predictive power of the model hinges directly on the assertion that the current value of the firm provides a good prediction on the future value of the firm. Credit Metrics Approach In April 1997, J.P Morgan released the credit metrics technical document that immediately set a new benchmark in the literature of risk management. This provides a method for estimating the distribution of value of assets in a portfolio subject to changes in the credit quality of individual borrower. A portfolio consists of different stand along assets, defined by a stream of future cash flows each asset has over the possible range of future rating class. Starting from its initial rating, an asset may end in any one of the possible rating categories. Each rating category has a different credit spread, which will be used to discount the future cash flows. Moreover, the assets are correlated among themselves depending on the industry they belong to. It is assumed that the asset returns are normally distributed and change in the asset returns cause the change in rating category in the future. Finally, the simulation technique is used to estimate the value distribution of the assets. Credit Risk+ Introduced by Credit Suisse Financial Products, Credit Risk+ is a model of default risk. Each asset has only two possible ends of period states: Default and Non-default. In the event of default, the lender recovers a fixed proportion of the total exposure. The default rate is considered as a continuous random variable. It does not try to estimate the default correlation directly. The default correlation is assumed to be determined by a set of risk factors. Conditional on these risk factors, default of each obligor follows a Bernoulli distribution. The final step is to obtain the probability generating function for losses. The losses are entirely determined by the exposure and recovery rate. Hence, while implementing Basel II, prime focus will be on regulation and risk management. After March 31st 2007, the banking industry will be ruled by bankers who learn to manage their risks International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 17

effectively. The banks may evaluate the utility of these models with suitable modifications to the country specific environment for fine-tuning the credit risk management. The success of credit risk models impinges on the times series data on historical loan loss rates and other model variables, spanning multiple credit cycles. Banks may therefore attempt building adequate database for switching over to credit risk modeling after a specified period of time. Credit Risk modeling results in a better internal risk management. Banks’ credit exposures typically are spread across geographical locations and product lines. The use of credit risk models offer banks a framework for examining this risk in a timely manner, centralizing data on global exposures and analyzing marginal and absolute contributions to risk. These properties of models may contribute to an improvement in a bank’s overall ability to identify, measure and manage risk. Credit risk models may provide estimate of credit risk (such as unexpected loss), which reflect individual portfolio composition; hence they may provide a better reflection of concentration risk compared to non portfolio approaches. Loan review, administration, and management (LRM) are an inherent process of credit management among banks. The obvious and more serious banking problems arise due to lax credit standards, poor portfolio risk management, or a lack of attention to changes in economic, or other circumstances that lead to a deterioration in the credit standing of a bank’s portfolio. Therefore, the banking industry has been focusing more attention than ever on risk management. At the same time, banking regulators from around the world are working out a complicated set of rules for governing global banks accorded in the Basel II Accord. Many credit problems reveal basic weaknesses in the credit granting and monitoring processes. While shortcomings in underwriting and management of market-related credit exposures represent important sources of losses at banks, many credit problems would have been avoided or mitigated by a strong internal credit process. Many banks find carrying out a thorough credit assessment a substantial challenge. For traditional bank lending, competitive pressures and the growth of loan syndication techniques create time constraints that interfere with basic due diligence. Globalization of credit markets increases the need for financial information based on sound accounting standards and timely macroeconomic and flow of funds data. When this information is not available or reliable, banks may dispense with financial and economic analysis and support credit decisions with simple indicators of credit quality, especially if they perceive a need to gain a competitive foothold in a rapidly growing foreign market. Finally, banks may need new types of information to assess relatively newer borrowers, such as institutional investors and highly leveraged institutions. Whilst refocusing of credit practices is essential, certain credit rating models that are being adopted still follow the outdated practices of the past, which focus on risk avoidance, rather than risk management and if banks seek to continually avoid risk, significant opportunities will be lost. As a consequence the banks will lose out to more sophisticated competitors. International business school, Kolkata

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However, banks have now become more sophisticated in their hedging and pricing of interest rate risk. New modeling methods are changing the way banks understand and handle credit risk. One has to wait and watch for the implications. 4) Country Risk this risk is the possibility that a country will be unable to service and repay its debts to foreign lenders in a timely manner. This risk arises due to exchange rate changes,due to restrictions on external remittance, political risk, cross border risk(on account of borrower being resident of country other than the country where the asset is booked). Definition of Risk management : Risk management is the sum of (1) Risk identification (2) Risk measurement (3) Risk monitoring and (4) Risk control with a view to maximize Risk Adjusted Return on Capital Employed=(RAROCE).

I R

K

Incident (outcome)

S Rare (unexpected) (measuring, monitoring, controlling)

Selection (Identification)

Normal Steps in term loan processing: Submission of Project Report along with the Request Letter.

Carrying out due diligence Preparing Credit Report

Determining Interest Rate International business school, Kolkata

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Knocking

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 19

Preparing and submission of Term Sheet If not approved

if approved

Preparation of proposal

Submission of Proposal to designated authority If No queries raised

Project Rejected

If queries raised

Sanction of proposal on various

Solve the queries

Communication of Sanction Acknowledgement of Sanction Application to comply with Sanction Terms & Condition & execution of Loan Documents Disbursem

Need for sound credit appraisal system & accurate risk assessment The global financial crisis has been hovering for almost two years now. Renowned financial institutions and corporate have become either bankrupt or had to be rescued. Economic growth has suffered setbacks and governments in even the wealthiest nations have had to come up with stimulus packages to bail out their economics, especially their financial systems. The IMF, in its Global Financial Stability Report released in April, 2009 forecasts that the losses due to global financial turmoil could be no less than $1.4 trillion, two-third International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 20

of which will have to be borne by banks. Though most of the losses pertain to the US and Europe, the report observes that emerging markets risks have risen the most in the last six months. If we speculate the causes briefly, We get:>Under pricing of risks :increase in subprime mortgages, >High prices lending to oversupply of housing in US, >Role of credit rating agencies: faulty and inadequate, >Excessive leverage and weak risk-management system, >Regulatory gaps and lax supervision >Inadequate information about the quality of assets in portfolios heightened counterparty risk perception and led to extreme risk aversion > Assets held by non-depository financial instruments (investment banks, hedge funds, etc) being largely financed by short term money market instruments that could not be rolled over , It all started from USA housing crisis (sub-prime crisis). The USA financial institutions went on lending to people for house construction without bothering to verify their repaying capacity. The houses were pledged with the financial institutions. When the prices of house properties crashed n the loanees failed to repay the loan, the financial institutions repossessed the properties but could not sell as prices had crashed. Many financial institutions went bankrupt. Studies carried out on bank failures in the US show that credit risk alone has accounted for 71% of large bank failures in this period. Credit risk is the oldest and biggest risk that a bank due to its nature of business. As banks move into a new globalised environment for financial operations and trading, with new risks the need is felt for better credit risk management techniques with more sophisticated and versatile risk instruments for risk assessment, monitoring and controlling risk exposures. The credit risk rating can be a risk management tool for prospecting fresh borrowers in addition to monitoring the weaker parameters and taking remedial action. It also provides a basis for Credit Risk Pricing i.e. fixation of rate of interest on lending to different borrowers based on their credit risk rating there by balancing risk &Reward for the bank and it gives the bank to maintain the level of capital in proportion to the risk of the loan. Basel capital accord and regulatory capital allocation requirements have also fuelled the demand for better credit risk measurement. Regulatory impose minimum standards to estimate credit risk for the purpose of capital allocation and performance measurement of banks .Adoption of sound risk based pricing mechanism International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 21

and RAROC(Risk Adjusted Return on Capital)concept for performance evaluation has also enhanced the need of better credit management practices.

CHAPTER - II International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 22

BANK PROFILE

Vision, mission and heritage of Bank of Baroda Shareholding pattern in Bank of Baroda Subsidiaries and joint ventures Exposures at different sectors Performance highlights Awards and achievements Types of credit offered by the bank Bob’s internal credit appraisal system

Vision

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 23

It has been a long and eventful journey of almost a century across 25 countries. Starting in 1908 from a small building in Baroda to its new hi-rise and hi-tech Baroda Corporate Centre in Mumbai, is a saga of vision, enterprise, financial prudence and corporate governance.

Mission To be a top ranking National Bank of International Standards committed to augmenting stake holders' value through concern, care and competence.

Heritage It all started with a visionary Maharaja Sayajirao Gaekwad 's uncanny foresight into the future of trade and enterprising in his country. On 20th July 1908, under the Companies Act of 1897, and with a paid up capital of Rs 10 Lacs started the legend that has now translated into a strong, trustworthy financial body, THE BANK OF BARODA. India’s 3rd largest public sector bank. Shareholding pattern as on 31st March, 2009 Sl No.

Category

1 2

Govt of India Foreign institutional investors 3 Mutual Funds 4 Insurance companies 5 Resident Individuals 6 Bodies corporate 7 Non resident individuals 8 Employees 9 Clearing members 10 Financial institutions/Banks 11 HUF 12 Overseas corporate bodies 13 Trusts 14 Foreign Nationals Total (Source: Annual Report 2008-2009)

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No.of Holders 1 132

Total Shares

% to Equity

196000000 49302690

53.81 13.53

128 18 178501 1637 3160 4048 148 28

44755788 34900318 23169522 11246747 2253893 833676 579908 913489

12.29 9.58 6.36 3.09 0.61 0.23 0.16 0.25

1586 4

263054 26200

0.07 0.01

23 1 189415

21099 116 364266500

0.01 0.00 100.00

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 24

Subsidiaries and joint ventures: Sr No. Subsidiary(domestic) 1 2 3

Name of the subsidiary

Extent of ownership

National Bank Ltd, BOBCARDS Ltd. BOB Capital market Ltd.

98.39% 100.00% 100.00%

Subsidiaries(foreign)

Associates (domestic)

Bank of Baroda (Botswana) Ltd. Bank of Baroda (Kenya) Ltd. Bank of Baroda (Uganda) Ltd. Bank of Baroda (Guyana) Ltd. Bank of Baroda (UK) Ltd. Bank of Baroda (Tanzania) Ltd Bank of Baroda (Trinidad & Tobago) Ltd. Bank of Baroda (Ghana) Ltd.

Baroda Pioneer Asset Management Company Ltd UTI Asset Management Company Ltd UTI Trustee Company Pvt. Ltd Baroda Uttar Pradesh Gramin Bank Baroda Rajasthan Gramin Bank Baroda Gujarat Gramin Bank Nanital -Almora Kshetriya Gramin Bank Jhabua-Dhar Kshetriya Gramin Bank

Associate(foreig n)

Indo-Zambia Bank

Joint venture(dome stic) Baroda Pioneer Asset Management Company Ltd., India First life Insurance Company Ltd.

Exposure of Bank of Baroda in different Sectors SR NO.

INDUSTRY

1 2

Power Petrochemicals/petro products(including petroleum) International business school, Kolkata

Bank of Baroda

BAL O/S AS ON 31/03/09(RS. IN CR.) 8359.59 8085.92

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 25

3 4 5 6 7 8

Iron & steel 5371.14 Synthetic Textiles 3374.56 Cotton Textiles 2141.22 Engineering 2076.37 Construction (Contractors, CRE developer/builders) 1763.47 Chemicals(except fertilizer, petrochemical & 1497.21 pharmaceuticals 9 Drugs & pharmaceuticals 1312.49 10 Plastic 1245.48 Area Outstanding(Rs. In cr.) Top 10 Industries 35227.38(75.66%) Rest 11327.71(24.34%) Total 46555.09(100%)

Bank of Baroda PARTICULARS

31.03.20 08 36774 2899 7.04 3.90

31.03.200 9 36838 2974 9.11 6.05

31.03.2010

No. of employees No of branches Business per employee(Rs. in crore) Net profit per employee(Rs. in lakh)

31.03.200 7 38086 2772 5.48 2.70

Earnings per share(Rs.) Book value per share(Rs.) Cost of deposit

28.18 231.59 4.77%

39.40 261.54 5.69%

61.14 313.82 5.71%

83.96 378.44 4.90%

Return on Avg.Assets (ROAA)(%) Avg.Cost of funds(COF)(%)

0.80 4.58

0.89 5.33

1.09 5.81

1.21 4.98

Deposits (Rs.in crore) Advances (Rs. In crore) Net NPA ratio

124916 83621 0.60

152034 106701 0.47

192397 143252 0.31

241045 175035 0.34

Interest Income(Rs. In crore) Other Income(Rs.in crore) Interest Expended (Rs.in crore) Operating Expenses(Rs.in crore)

9004 1382 5427 2544

11813 2051 7902 3034

15092 2758 9968 3576

16698 2806 10758 3810

International business school, Kolkata

Bank of Baroda

38960 3148 10.68 7.85

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 26

Financial Year

Percentage Growth

2007-08

31.11%

2008-09

24.18%

2009-10

43.98%

Performance Highlights (Year ended March 31, 2010) Total Business (Deposit + Advances) increased to Rs4,16,080 crore reflecting a growth of 24.0%. Gross Profit and Net Profit were Rs 4,935 crore and Rs 3,058 crore respectively. Net Profit registered a growth of 37.3% over previous year. Credit-Deposit Ratio stood at 84.55% as against 81.94% last year. Retail Credit posted a growth of 23.5% constituting 18.15% of the Bank’s Gross Domestic Credit in FY10. Net Interest Margin (NIM) in global operations as percent of interest earning assets was at the level of 2.74% and in domestic operations at 3.12%. Net NPAs to Net Advances stood at 0.34% this year against 0.31% last year. Capital Adequacy Ratio (CAR) as per Basel I stood at 12.84% and as per Basel II at 14.36%. Net Worth improved to Rs 13,785.14 crore registering a rise of 20.6%. Book Value improved from Rs 313.82 to Rs 378.44 on year. Business per Employee moved up from Rs 911 lakh to Rs 1,068 lakh on year.

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 27

Awards and achievements The Bank’s consistent performance accompanied with various marketing efforts has helped improve the Bank’s Brand Ranking in the Indian banking industry. It is evident from the results of various independent media surveys as given below. ‘Bank of the Year Award' in India Leadership Conclave at Delhi by Wockhardt Foundation - 14th Sep. 2009. SKOCH Challenger Award for ‘Bank of the Year’ - 18th March 2010. Second Rank as ‘Best Nationalized Bank’ in ‘India’s Best Bank Survey 2009-10’ by Financial Express Group. Rank 34 [up from Rank 39 last year] - India’s Most Valuable Brand 2009 (Brand Finance, UK) Rank 33 [up from Rank 36 last year] – ET 500 2009 Rank 4 [up from Rank 17 last year] – Business Today KPMG Survey 2009. The Bank has also been awarded a ‘Gold Trophy’ for the Indian Language Publication, a ‘Silver Trophy’ for the Corporate Website and a ‘Bronze Trophy’ for Bilingual Internal Magazine and Chairman & Managing Director’s message (in Corporate Communications category) by the Association of Business Communicators of India (ABCI). Type of Credit facilities offered by the bank Credit facilities can be fund based or non-fund based. Fund Based Facilities are those where outley of the bank’s funds is involved. Here the bank provides funding and assistance to actually purchase business assets or to meet business expenses. Fund Based facilities are facilities are generally granted by the way of overdrafts, Cash credit, Demand loans, Working Capital Term Loans, Bill purchased/Discounted and Term Loans Non-Fund Based Facilities are those where the bank has to meet the commitment/promise made by a borrower and endorsed by the Bank, only if the borrower fails to honour it. Here the bank can issue letters of credit or International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 28

can give a guarantee on behalf of the customer to the suppliers, Government Departments for the procurement of goods and services on credit. The main types of facilities under fund based and non-fund based and the related guidelines for granting advances against them are discussed below in brief.

Fund Based Facilities: The different fund based credit facilities offered by the bank are as follows: 1. Working Capital Loans: A firm’s working capital is the money it has available to meet current obligations (those due in less than a year) and to acquire earning assets. The working Capital funding requirements for the clients are partly made out of the short term funding provided by banks, the balance being funded out of long term sources of the client. The primary security for working capital limits is normally hypothecation of the current assets of the company. The bank offers Working Capital finance to meet the operating expenses, purchasing inventory, receivables financing, either by direct funding or by issuing letter of credit. 2. Overdraft and Cash credit: In overdraft/cash credit, the borrower is allowed to carry out debit and credit transactions up to a limit. These are more operative accounts and have cheque book facility. The term “overdraft” is generally used for continuing limits granted against the security of term deposits and other financial securities, occasional overdrawing /debits in current accounts and also for continuing limits granted for working capital requirements of commercial establishments. Cash credit /overdraft limits are repayable on demand. 3. Export Finance: According to RBI guidelines, the banks are required to provide loans to exporters at concessional rates of interest as advised by RBI from time to time, for promoting export from our country. The export credit / finance is provided by the bank in Rupees as well as foreign currencies for pre-shipment and post-shipment requirement of the exporters. Pre –shipment facilities are extended against export orders and post shipment facilities are extended by way of bill discounting and bill purchase. 4. Term Finance: Term finance/loans are primarily provided by bank for capital expenditure/acquisition of fixed assets for starting / expanding a business or industrial unit. These loans are typically secured by the real and personal property financed by the bank as well as other assets of the borrower. They are repayable by specific number of installments spread over a period of 3 to 5 years or some times more. 5. Bill Finance: In order to ease the pressures on cash flow and facilitate smooth running of business, the bank provides Bill Finance to its corporate / non corporate clients. It is normally meant for financing working capital requirements in the post-sale part of the operating cycle of a unit. The facilities are for purchasing / discounting bills drawn by the customer for goods sold. International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 29

6. Demand Loans: As the name suggests, are repayable on demand. They are also at times referred to as loans. Though technically repayable on demand, a repayment of the loan in installments spread over a period up to 3 years or so is generally stipulated. Composite loans given for working capital and for fixed assets as also the loans for fixed assets where repayment period is stipulated up to 3 years are generally granted by the way of Demand loans.

Non Fund Based Facilities: The two main types of non fund facilities are Letter of Credit and Bank Guarantees the details of which are given as follows: 1. Letter of Credit: LC (letter of credit) is an arrangement where a bank, acting on the request of the customer (importer/opener of letter of credit), gives an undertaking to a third party (exporter/beneficiary of the letter of credit) that on submitting the shipping documents (drafts, invoices, insurance policy, bill of landing), the bank will meet the trader’s commitment. In international trade, given the fact that the local trader might not be known to the foreign supplier, such assurance from a bank facilitates the business. 2. Bank Guarantees: Issuing guarantees on behalf of customers is a major non-fund based business of banks. A guarantee is a contract to perform the promise or discharge the liability of a third person in case of his/her default. It constitutes a contingent liability that arises in the event of default by the customer. In this project I have dealt with the following three types: Key benefits of Working capital finance (ANNEXURE-I shows the interest rate applicable for working capital finance): Funded facilities i.e. the bank provides funding and assistance to actually business assets or to meet business expenses. Non funded facilities i.e. the bank can issue letters of credit or can give a guarantee on behalf of the customer to the suppliers, govt. departments for the procurement of goods and services on credit. Available in both Indian as well as foreign currencies. International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 30

Under term finance Bank of Baroda offers the following: (ANNEXTURE- II shows the interest rate applicable for term loan finance)

>Fund based finance for capital expenditure/acquisition of fixed assets towards starting/expanding a business or industrial unit or to swap with high cost existing debt from other bank / financial institution. > Non fund based finance in the form of deferred payment, guarantee for acquisition of fixed assets towards starting / expanding unit. Under Project finance BOB provides its customers with the option of a loan to take care of the needs of an ongoing project, whether it is in Indian or Foreign currency.

CHAPTER - III

posal and appraisal

in carrying out the Credit Rating of Commercial Advances

applicability criteria for individual sectors

credit appraisal system

Bank’s Credit Screening Process:

International business school, Kolkata

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Term loan

Steps invol

Credit Rati

Bob’s inter

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 31

Internal Credit Appraisal and Rating Methodology of Bank of Baroda: The New CRISIL Rating models or BOBRAM model for commercial advances are based on two dimensional rating methodology specified under Basel-II Accord requirements. The credit risk rating process as per New CRISIL/BOBRAM Rating Models involves three types of ratings for each credit facility:1) Obligor (Borrower) Rating – for credit worthiness indicating the Probability of Default. (PD) 2) Facility Rating - representing the Loss Given Default (LGD).Evaluation of riskiness of a facility; 3) Composite Rating – Indicative of the Expected Loss (EL).

Risk rating flowchart, under CRISIL New rating model as shown in this diagram: International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 32

Facility Post Project Obligor project Risk Risk Obligor Composite implementati Implementati Rating Rating(indicator Rating rating on >Project (indicator of LGD) >Industry Risk Impl. ofof >Industry (indicator Risk >Construction >Post PD) Risk Project EL) >Business Risk Implementation Evaluation >Funding of >Business Risk credit Risk >Financial worthiness >Financial Risk Risk >Management >Manageme Risk nt Risk

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 33

1. OBLIGOR (BORROWER) RATING: The obligor (borrower) rating is indicative of creditworthiness of an obligor or the probability of default (PD) and it is based on the assessment of past and projected cash flows of the company. For assessment of an obligor, the rating structure consists of evaluation by way of four modules: a) Industry Risk: The assessment of this module which is external to the Borrower and is done by assessment of industry related macroeconomic parameters applicable to the specific industry and having different risk weights. b) Business Risk: The assessment of this module is based on internal working of the borrower and relates to parameters such as after sales service, distribution set up, capacity utilization etc. The parameters which are only relevant to a particular industry, are selected for scoring having different risk weights. c) Financial Risk: The assessment of this module is based on internal working of the borrower and relates to parameters such as past (not in case of a green field / infrastructure company under implementation stage) and projected financials .The CMA based data input sheet is uploaded into the software and the same allows computation of financial rating automatically based on the computation of financial ratios like net profit margin, current ratio, DSCR, interest coverage etc. d) Management Quality: The assessment of this module is based on internal working of the Borrowers management and relates to parameters such as past repayment record, quality of information submitted, group support etc.

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 34

Obligor (Borrower) Rating Grades Obligor Rating Grades range from BOB-1 to BOB-10. Grade No

I

II

III

IV

Nature of Grade

BOB-1

Description

Investment GradeHighest Safety

Companies rated BOB-2 are judged to offer high safety of timely payment. Changes in circumstances providing this degree of safety have low impact on the fundamentally strong position of such issues.

Investment Grade High Safety

Companies rated BOB-3 are judged to offer high safety of timely payment. This differ in safety from BOB-2 only marginally.

Investment Grade Adequate safety

Companies rated BOB-4 are judged to offer adequate safety of timely payment. However changes in circumstances can adversely affect such issues more than that those in higher rated grades.

Investment Grade Moderate safety

Companies rated BOB-5 are judged to offer moderate safety of timely payment of interest and principal for the present. However changing

BOB-4

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Companies Rated BOB-1 are judged to offer highest safety of timely payment. Though the circumstances providing this degree of safety is likely to change, such changes as can be envisaged are more unlikely to affect adversely the fundamentally strong position of such issues.

Investment Grade High Safety BOB-2

BOB-3

Definition of Obligor Grade

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 35

V

VI

VII

VIII

IX

BOB-5

BOB-6

circumstances are likely to lead to a weakened capacity to repay interest and principal than for the companies in higher rated grades. Investment Grade Moderate safety

Companies rated BOB-6 are judged to offer moderate safety of timely payment of interest and principal for the present. There is only a marginal difference in the degree of safety provided by issues rated BOB-5..

Sub investment Grade Inadequate Safety

Companies rated in BOB 7 are judged to carry inadequate safety of timely payment..While they are less suspectible to default than other speculative grades in the immediate future, the uncertainties that the issuer faces could lead to inadequate capacity to make timely payments.

Sub investment Grade-High Risk

Companies rated BOB-8 have a greater susceptibility to default .While currently payments are met, adverse business or economic conditions can lead to lack to ability or willingness to repay.

Default Substantial Risk

Companies rated BOB9 are vulnerable to default. Timely payment of interest and principal is possible only if favourable circumstances continue.

Default

Companies rated BOB 10 are in default or are expected to default on maturity. Such investments are extremely speculative and returns from these may be realised only on re-organisation or liquidation.

BOB-7

BOB-8

BOB-9

X BOB-10

However depending upon the model used, the rating grades ranging from BOB-1 to BOB-10 or BOB-3 to BOB-10 or BOB-6 to BOB-10 are generated as follows: SR.NO

MODEL

.

International business school, Kolkata

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Obligor(borrower) Rating Grades

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 36

a)

For Borrowers under large corporate (Mfg/services), Banks, NBFCs and Broker categories.

b)

For Borrowers under infrastructure project

BOB-1 to BOB-10

having operations phase or expansion/diversification projects categories a)

b)

For Borrowers under SME SME

(manufacturing) and

BOB-3 to BOB-10

(service) categories. For existing and new borrowers under Trader Category. Green Field Project Borrowers under Large Corporate

BOB-6 to BOB-10

(Mfg/services) with project, SME((Mfg/services) with Project and infrastructure (power/Port/Road/Telecom) Build phase categories. The detailed score- wise pattern for various Obligor (Borrower) Ratings under above stated models are given in ANNEXURE-I. 2. FACILITY RATING: Facility rating involves assessment of the security coverage for a given facility and indicates the loss given default (LGD) for a particular facility. Facilities proposed/sanctioned to a company are assessed separately under this dimension of rating. Facility Rating (FR) Grades: Facility Rating grades range from FR-1 to FR-8 (ANNEXURE-II) 3. COMPOSITE RATING: Composite Rating(CR)- this is the matrix or the combination of PD and LGD; indicates the expected loss in case the facility is defaulted. The Composite rating is worked out automatically by the software based on the obligor (Borrower) Grade (BOB Rating) and Facility Rating grade(FR). Composite Rating grades: CR grade ranges from CR-1 to CR-10 (ANNEXTURE-III) International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 37

4. CUT OFF GRADE FOR ACCEPTANCE: Bank has accepted BOB-6 as the cut-off point for the acceptance of an obligor (borrower) based on Obligor (borrower) rating carried out as per the applicable model. The rating models have been grouped in three categories for the purpose of specifying cut-off point for the acceptance of an obligor (borrower) as per details mentioned here under: a) Borrowers/ obligors eligible for rating under LCM (Manufacturing /Services),Banks, NBFCs, Broker

Models, Infrastructure project under operations phase (having started cash generation) and expansion/diversification projects in case of exiting borrowers . The past financial data for these categories of borrowers is usually available. The acceptance grade for these borrowers can be any grade from BOB-1 to BOB-6.BOB-6 having the score range of above 4.25 to 5.oo out of total 10.00 for these categories of borrowers. (ANNEXTURE-IV) b) For borrowers /obligors eligible for rating under SME(manufacturing) / SME (service) and Traders Models in case of existing borrowers : The past financial data for these categories of borrowers are usually available. The acceptance grade for these borrowers can be any grade ranging from BOB-3 to BOB-6.BOB-6 is having the score range of above 5.00 to 5.75 out of total 10.00 for these categories of borrowers. It may be noted that for these category of borrowers, the highest creditworthiness works out to be BOB-3. (ANNEXTURE-V) c) Obligors (borrowers) with new projects eligible for rating under infrastructure (build phase)/ and Green Field projects(LCM/SME): The past financial performances data in respect of these categories of borrowers are not available and only future projections are available. These borrowers are initially rated under Project Risk rating and assigned rating grades from BOBPR-1 to BOBPR-5 and subsequently converted into common obligor(Borrower) rating grade from BOB-6 to BOB-10 automatically. Thus BOBPR-1 is equivalent to BOB-6 and BOBPR-5 is equivalent to BOB-10.In other words ,BOBPR-1 under project rating is the only investment grade being equivalent to obligor/Borrowers rating scale of BOB-6 applicable scenario for these categories of borrowers are as follows: Model LCM(Green Field) LCM (Service sector)

From score Above 4.5

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To score 5.00

Highest Score 5.00

Grade BOBPPR-1

Common Scale BOB-6

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 38

SME(Mfg/Ser)-(Green field)

Above 7.00 Infrastructure(Power/Port/Telecom/Port) Above Built phase 4.5

8.0

8.00

BOBPPR-1

BOB-6

5.00

5.00

BOBPPR-1

BOB-6

5. PRICING: The composite rating or the combined rating(CR-1 to CR-10) is computed on the basis of matrix of obligor rating for credit worthiness and the facility rating representing the expected loss in case of default. This loss has to be recovered from the borrower by way of risk premium over the BPLR. For the purpose of fixing of rate of interest the mapping of existing (AAIPL models) rating grades with the BOBRAM / CRISIL Rating Models is as under:Grade No.

Nature of grade

Definition of composite/combined Grades

I

CR-1

II III IV V

CR-2 CR-3 CR-4 CR-5

VI VII VIII IX X

CR-6 CR-7 CR-8 CR-9 CR-10

Minimum(lowest)Expected loss Lower expected loss Low expected loss Reasonable expected loss Adequate converable Expected loss Moderate Expected loss Extra Expected loss High probability of loss Higher Probability of loss Highest Expected Loss

Rate of interest for borrowers to be mapped with existing Ratings as under AAA AA A/BBB BB B C C D D D

6. TECHNOLOGY EMPLOYED FOR NEW (CRISIL) RATING SYSTEM: The credit risk rating application is central server based. For doing the rating the various advances accounts, software is already located in the main server can be accessed through internet. Thus the computer used by various users in the bank like risk rating officer, validates, sanctioning authority etc located at various places must have internet connection. The internet explorer (minimum 5.5 versions) can be used as the browser for the purpose of credit risk.

Credit Rating applicability criteria for individual sectors A robust credit rating system enables the bank in determining the probability of default and the severity of default among its loan assets and thus allows the bank to built systems and initiate measures to International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 39

maintain its assets quality. Bank of Baroda has a strong credit rating system. The bank earlier used the AAIPL method i.e. M/S Arthur Anderson (I) P ltd. Which was the traditional method. Banks Consultants on risk management M/S Arthur Anderson (I) P ltd. has suggested for introducing new credit rating model i.e. CRISIL rating models, for adopting the current day techniques in credit risk management. The applicability of new BOBRAM / CRISIL model is as follows: Sr.no. Model 1 Large Corporate

Applicable for rating of 1. Manufacturing units with annual net sales of over Rs.50cr. 2. Service sector units with net annual sales over Rs.50cr. Manufacturing units with annual net sales of over Rs.50cr.and below

2

SME (Manufacturing sector) incl. commercial Enterprise

3

SME(services)

Service sector units with net annual sales over Rs.50cr and below

4

Traders

Units engaged in trading activities irrespective of sales turnover

5

Banks

Organisations engaged in banking activities

6

NBFCs

Organisations registered with RBI/NHB for carrying out nonbanking financial activities/housing finance activity

7

Brokers

Entities engaged in broking business in shares / securities

8

Infrastructure(Power)

Infrastructure-Power Projects(Generation and Distribution) Build stage i.e.implementation stage where cash generation from the project is not yet started

9

Infrastructure (roads & bridge)

Infrastructure-Roads & Bridge Projects -Build stage i.e.implementation stage where cash generation from the project is not yet started

10

Infrastructure (Ports)

Infrastructure-Port Projects- Build stage i.e. implementation stage where cash generation from the project is not yet started

11

Infrastructure (telecom)

Infrastructure-telecom Projects- Build stage i.e. implementation stage where cash generation from the project is not yet started

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 40

Steps involved in carrying out the Credit Rating of Commercial Advances Step1: Selection of appropriate model: Based on the criteria, the applicable model is to be selected for rating exercise. Step2: Datasheet preparation (off line model): Having selected one of the applicable models for rating purpose, only the prescribed CMA data based input sheet and/or project profitability data input sheet and /or project profitability data input sheet downloaded from bank’s Intranet or provided through CD during the training is to be used. The sheet is to be filled by credit officers in the offline mode after the due –diligence of the CMA/project financials by the appropriate authority. We have to note that the prescribed input sheet has to be used for the purpose of data entry and subsequent uploading during the rating process. Step3: Rating Exercise: The login and password is allotted at the regional or zonal office. A credit officer is supposed to study the company’s operations and rating parameters. The credit risk rating process as per New CRISIL rating models involves three types of rating for each credit facility viz.1) Obligor(borrower) rating for credit worthiness indicates the PD.,2)Facility Rating representing the LGD and 3) Composite rating-which is indicative of the Expected Loss (EL) Step 4: Facility Rating After completing the obligor rating (Industry Risk, Financial Risk, Business Risk, Mgt. Quality) as above, Facility rating is to be carried out. For this purpose the security value is to be appropriated first against the respective facilities and thereafter the excess security over the outstanding amount of facility enjoyed is to be worked out This excess security is distributed over the remaining facilities in proportion of availment.FR grades range from FR-1 to FR-8.This methodology is explained as below: Facility Risk rating is based on the Basel approach for the calculation of loss given default(LGD).The final facility rating grade is assigned on the basis of the % effective LGD for each facility.(How to calculate) Step 5: Composite Rating This rating is automatically worked out ,once the obligor rating and the facility rating are in place With the completion of above 5 steps, the credit risk rating process is over. International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 41

Step6: Submission of the credit rating to the validator The credit rating officer has to comply the following steps: Get 2-hard copy print outs of the “interim company report” from the report section in the online mode.The relevant PDF file of interim company report has to be saved for records. One copy of the “interim company report” has to be sent to validator.The credit officer has also to send the hard copies of financial data (audited and provisional) alongwith relevant records used during the risk rating process. Credit risk rating done on the software has to be submitted online to the validator(located at the office of sanctioning authority) for further processing. Step 7: Validation The validator has to comply the following steps: The validator is required to validate the credit risk rating based on the financial data(audited and provisional) and other relevant records, which have been used during the credit risk rating process by the rating officer. However all the proposals falling under the power of branch manager are to be validated at the regional office or the reporting authority level as the case may be. After due validation, the validator is required to take three hard copy printouts of the “interim company report” and send one copy to the credit rating officer, the other copy to sanctioning authority and third must be kept on records Validator is required to submit the validated credit rating report to appropriate sanctioning authority through the system. 8. Submission of validated credit risk rating report and other MIS reports to the sanctioning authority The sanctioning authority has no role during the process of credit rating also during the process of validation. After the completion of validation process, the concerned credit officer at the office of sanctioning authority will receive the hard copy of the validated rating from the validator and also a soft copy through the system. A copy of the validated rating report is to be attached to the proposal. The following reports could also be generated through the system: Company comparison report Financial reports (all levels) via CMA financials, project financials, ratios International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 42

MIS reports like ASCORM industry wise, borrower group wise etc. as desired by the authority Strength and weakness report.

CASE STUDY On Interim Company Rating Report Model Name: SME – Service model. Company Name: ABC Ltd. Industry Name: Service. Rating Year: 2010 Summary Table: Date

2007

2008

2009

2010

Score

7.24

7.63

8.23

7.26

Grade

BOB 5

BOB 4

BOB 4

BOB5

Rating Summary: Borrower Rating

Score

Prv. score

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Rating

RAROC (%)

Rating Class

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 43

Single-scale rating

7.27

7.26

BOB 5

8.4282

Investment Grade (Moderate safety)

Meaning: Companies rated BOB 5 are judged to offer moderates safety of timely payment of interest and principal for the present. However changing circumstances are likely to lead to a weakened capacity to repay interest and principal than for companies in higher rated grades. Model Scale Rating: Risk Entity Name

Score

Grade

Company Rating

6.3

IV

Industry Risk

6.67

III

Business Risk

6.59

III

Financial Risk

5.35

V

Management Risk

6.63

III

Facility Rating: Particulars

% Effective LGD

Rating

RAROC (%)

Combined Rating

Cash Credit General

40

FR 3

51.6126

CR 4

Bank Guarantee Inland

60.78

FR 5

(12.5924)

CR 5

Fgn. Specific Score Sheet for ABC Ltd. Risk Entity Name International business school, Kolkata

Bank of Baroda

Value

Score

Grade

Strengths/Weakness

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 44

Type: Company INDUSTRY RISK:

6.67

1) Competition

III

4

Comments: Lots of players with further scope of new players to enter the industry. Significant threats from imports exist. There are so many construction companies/promoter/builders/players in the market. Competition exists amongst them to procure work orders. 2) Demand Supply Scenario

8

S

Comments: Past growth rates relatively high and stable. Positive demand-supply gap scenario. Relatively insulated from economic recession. Favourable growth rate likely to continue in the medium term. However, product off take not as easily assured as higher grades. The industry scenario is favourable and a lot of scope is available in the field of construction. 3) Availability of HR

8

S

Comments: HR are available, salaries are steady. The man power is easily available. Risk Entity Name

Score

Grade

BUSINESS RISK:

6.59

III

Market position

6.5

1) Assessment of immediate buyer

Value

Strengths/Weakness

6

Comments: Mr. A and his group have successfully completed both govt. and non govt. jobs. At present, the company’s bulk orders is from Chattisgarh Housing Board and it being a State govt. undertaking, Score of 6 is justified. 2) Position of entry in its target market

4

Comments: Average the company is led by experienced and reputed promoter Mr. A, having experience of more than 10 years. 3) Perceived Service Quality

8

S

Comments: The quality of service provided is very good; promoter has good reputation and is timely service provider in the area of civil construction.

International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 45

4) Capacity / Potential for Innovation /

8

S

Creativity Comments: Very good capacity. Promoter is capable of handling big construction projects as past records suggest. Operating Efficiency

6.67

1) Utilization Efficiency

8

S

Comments: Very close to maximum capacity utilization. The resources are properly utilized and there is optimum utilization of resources. 2) Process and Controls

6

Comments: Adequate controls and process. The processes are well defined and adequate to control the activity with efficiency. 3) Ability to attract quality resources

6

Comments: Above average; the company, is able to attract good quality resources. The company is hiring well experienced engineers and personal for its ongoing project at Durg.

Risk Entity Name

Value

Score

Grade

FINANCIAL RISK

5.35

V

Past Financials

5.16

Strengths/Weakness

Receivable days – past (days)

45.18

8

Tangible Networth – past

369.28

4

NCA / TD – past (ratio)

1.55

10

Current Ratio – past (ratio)

1.06

4

TOL / TNW – past (ratio)

10.62

0

W

ROCE – past (%)

39.75

10

S

Interest coverage Ratio – past

47.06

10

S

Net profit margin (%) – past

7.65

8

S

International business school, Kolkata

Bank of Baroda

S

S

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 46

Contingent Liabilities (deflator)

1

Comments: Low Impact Accounting quality – past (deflator)

1

Comments: Good Future Financials

5.4

Interest coverage Ratio - projected

12

10

S

Tangible Networth - projected

1397.32

10

S

Receivable days – projected (days)

10.82

0

W

Current Ratio – projected

2.07

10

S

NCA / TD – projected

0.36

10

S

TOL / TNW – projected

2.6

0

W

Net profit margin (%) - projected

6.84

8

S

ROCE – projected (%)

45.23

10

S

Financial Flexibility

6

Ability to raise fund / debt

6

Ability to raise debt from Banks / Financial

6

Institutions Comments: Slightly above average. Ability to raise L T Debt / TNW and TOL / TNW based on ABS as on 31.3.09 are 0.21 and 10.59 respectively. External Credit Rating is P4 (Done by CRISIL). Ability to raise Equity

6

Ability to raise debt from own sources

6

Comments: Slightly above average.

Ability ….. Personal wealth of the promoters is good. CR, LT

Debt / TNW and TOL / TNW based on ABS as on 31.3.09 are 1.06, 0.21 and 10.59 respectively. External Credit Rating is P4+ (Done by CRISIL).

Risk Entity Name International business school, Kolkata

Bank of Baroda

Value

Score

Grade

Strengths/Weakness

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 47

MANAGEMENT RISK 1) Management succession plans

6.63

III

6

Comments: Company’s operations are fairly dependent on the present leadership for strategic direction. Both husband and wife are directors of the company. The company is dependent on them for day to day works. 2) Payment Track Record

6

Comments: A few payments were delayed but settled within 30 days; payment record of the company is quite good. 3) Group support: Financial interaction with

8

S

group companies. Comments: The company is of strategic importance to the parent, and would definitely derive support in times of financial stress. The group has 5 companies. The old company likely to extend support in case of financial crunch. 4) Litigations against the entity

10

S

Comments: Extremely clean track record with not a single case of litigation. No pending litigation reported against the company. 5) Years of experience in same line of

8

S

business Comments: The management has been in business for more than 10 years but less than 15 years. The promoter has more than 10 years of experience in the line of construction business. 6) Nature of management

5

Comments: Family as well as professional the company is directed by Mr. & Mrs. A and also assisted by the qualified professionals as well. 7)Credentials of the family running / owning

6

the business Comments: Reputed but first generation Mr. A is a first generation promoter but has good reputation in the market.

International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 48

8) Competence / Technical skills of the

4

management Comments: Competent management is competent but need to be more efficient.

Term loan proposal and appraisal:-Term loan are those loans which are payable within a period of more than one year and up to ten years. It is availed for acquisition of fixed assets i.e. land, factory building, warehouse, machineries etc. these are financed by way of term loan which is paid by the borrower in concern out of the profits earned. The schedule of repayment and duration of loan are fixed on the basis of assessed ability of the undertaking to generate surpluses for making repayment. There are five sections which are duly considered while considering the proposal. They are: Section-I: details of the proposal Section-II: financial parameters and assessment Section-III: Industry perception Section-IV: techno-economic viability (TEV) report Section-V: credit rating report SECTION-I: DETAILS OF THE PROPOSAL In this section, there is a detailed proposal for fresh consideration of term loan, further extension of term loan with any decrease or increase in the fund based and nonfund based limits. or any concession in upfront fees and also mentioned about the details of the applicant company, details of the project, details of the personal guarantees of the directors, details of the securities, previous rating done by the bank. etc. (ANNEXURE IV) SECTION-II: FINANCIAL PARAMETERS AND ASSESSMENT The financial performance is checked on the basis of balance sheet for last two years and projected next two years. Also the profit and loss account provides with the operational data. There are also working capital assessment data, assessment of sales, different profitability ratios are available.(ANNEXURE V)

International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 49

The term “Working Capital” denotes requirement of capital sum or amount of money business enterprises for day to day activities like purchase of raw materials, stores and spares, payment of wages to employee, payment of other expenses like energy, fuel, water consumption rates and taxes, carriage expenses. The bank normally define the working capital as the sum total of inventory, receivables and other current assets held by the business entity. It is computed by the banks through the concept of operating cycle i.e.it is taken by the business entity to get the money released from its current assets. The various methods for financing of working capital: 1. Tandon committee/Chore committee: A committee headed by Shri P L Tandon was constituted with a view to suggest improvement in the existing cash credit system. The committee has recommended three methods of lending: 1st method of lending:- According to this method, banks would finance 75% of working capital gap i.e.CA-CL 2nd method of lending:- According to this method ,banks would finance maximum up to 75% of the total CA. 3rd method of lending:- It is the same as 2nd method, but excluding core CA from total assets and the core assets is financed out of long term funds. 2. Nayak Committee/Turnover Method: The committee headed by Shri P R Nayak examined the adequacy of institutional credit to SSI sector and gave its recommendation which is that bank should give preference to village, tiny industries and other SSI units in that order. Under this method the 25% of the projected turnover is computed as the working capital and out of this 25% the borrower needs to bring in 5% as margin. 3. Cash Budget System: By projecting future cash receipts and disbursements, the cash budget enables the corporate to determine its cash needs. This method shall be followed in Sugar, Tea, Woolen garments industry and other seasonal industries. SECTION-III: INDUSTRY PERCEPTION It indicates the overall environment in which the industry is operating. In industry profile various parameters on which scores have been given. First and foremost all the details of the industry are given i.e. the various sub International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 50

sectors of the industry, updates covering the analysis of the critical issues and recent developments. Details regarding the industry are given in the following way: Background consists of

>Industry segmentation >Domestic industry size >Industry critical factors like

power/fuel cost, International competitiveness, cyclicality/ seasonality, input or raw material availability and affordability, global scenario. Major events in the industry consists of >Mergers and acquisitions >Announcements by industry associations like FICCI/CCI/ASSOCHEM etc. Bank experience/ Position on exposure: Over here the list of major borrowers along with their details has to be mentioned. The following parameters are looked into for an industry sub sector: A) Background: This head contains details regarding the background of the sector like inputs used, production process, quality of finished products and capacity utilization.etc. B) Assessment under industry risk parameter: This head contains details like Demand Supply gap:- This head contains details of the gap between demand and supply. It contains details like the reasons for increasing or decreasing demand ,availability of raw materials, price scenario, details of capacity utilization etc. Government Policies:- This head contains details of the various of the Govt. policies implemented like the increase or reduction in import duty, Govt. protection etc and its effect. Input related risk:-This head gives us the details regarding the various inputs required and the risk attached to them like the effect of increase or decrease in their domestic as well as international prices, consequences of over and under supply.etc Extent of competition: - this head tells us of the major players operating in the particular industry. It also tells us about the threats of the new entrants, future scenario, impact of price and profitability. Through this head a company can get important details which can help the company to divert risk. Financial risk:- This is a very important section. It contains the key ratios like ROCE, operating profit margin. It contains sector aggregates like current ratio, DE ratio, net profit margin etc and cost aggregates like raw material cost. power cost, selling cost etc also through this head we can know about International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 51

the various companies used for calculating the sector aggregates. All these information are taken from CRIS INFAC. Then a business risk evaluation is done (out of the total marks of 100).This is divided into two sections namely: Parent Operating Efficiency: This head contains entity like capacity utilization, management of price volatility, availability of raw material, integration of operation etc. On all these risk entity certain weight-age is assigned and remarks are written. Parent-Market Position: This head contains risk entity like longterm contracts, diversified market, proximity to markets, financial ability to withstand price competition etc. Again on all these risk entity certain weights age is assigned and remarks are written. SECTION-IV: TECHNO-ECONOMIC VIABILITY (TEV) REPORT TECHNO-ECONOMIC VIABILITY (TEV) ANALYSIS After a Credit Rating report is generated, the loan proposal is sent for TEV analysis. In TEV analysis the project report submitted by the borrower is thoroughly studied by the industry manager. The TEV analysis either done internally by the officers in the bank or it can be done externally also through some hired agency. In this analysis each and every aspect of the proposal is verified and necessary documents are gathered. In case of Green-Field or Brown-Field project the representative of the bank personally visits the site of the project and verifies the details, according to the proposal submitted by the borrower. After going through the above mentioned process the bank prepares a TEV analysis according to its prescribed format. I went through a couple of life case file of a few companies, the TEV report of which was done by BANK OF BARODA. The parameters which are generally looked into by the bank are to carry out a TEV analysis are: 1) Introduction: This head contains sections like: Background: Over here details of the company and its group companies right from its address to its current and proposed projects are looked into. Detailed Project Report (DPR): The details of the project along with its constitutions, promoters and the different phases of the project are looked into in details. Also details like the acceptability of project cost, technology involved, and implementation schedule, basic assumptions in assessing cost etc. are looked into. International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 52

Others: The details of the company, its management and other group companies are also looked into. 2) The proposed project, promoters, brief history of the company and group companies: This head contains details like the – Proposed project: It contains details like installed capacity, the products to be manufactured, the promoters of the company etc. Project cost and means of finance: This section contains the cost of the project in details and contains its various means of finance which is either through share capital or term loan. The Promoters: This leads every possible detail about the promoters and the directors are provided. Details like name, age, qualification, experience, etc. are given. Through this information a lot can be known about the capabilities of the promoters and directors. Group companies: This head contains the names of the various group companies, their respective date of incorporation, address, details of existing manufacturing capacity and financial position along with other relevant details. Location: This head gives us the details of the exact location of the land. It tells us about the various factors which were kept in mind before choosing that particular location i.e. availability of raw material, transportation, infrastructure and ready market. It also gives us the construction details. 3) Technology and Manufacturing process: This head gives us the details of the various technical consultants with adequate experience adopted by the company in setting up the respective plants as mentioned above. It gives us the details of both the technical consultants adopted and the plants set up by them. This head the details of various machineries used along with their production capacities are mentioned. Through this head we can also know about the various vendors with whom settlements have been made. This head also gives the details regarding the manufacturing process being used along with the manufacturing capacity. The various steps taken in manufacturing are also mentioned in this head. 4) Utilities and Service, Pollution Control: This head contains details like:Utilities: This head gives us the details of the man power planning which is very essential as it can help to reduce the cost and time of production. It tells us about the labour requirement and availability. Through this International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 53

head I also get other details like auxiliary facilities, power system, water system, fuel handling system, ash handling system, compressed air system, dust extraction system, communication, quality control, working capital requirement etc. Service, Pollution Control: This head tells whether all the proper permission has been taken from the competent authority or not. It also tells what steps has been taken by the company to prevent and control pollution and what steps has been taken to fulfill its social obligations. Licensing/Registration: There are certain Government rules and regulations which is necessary for every company has fulfilled its licensing and registration obligations properly. 5) Marketing and Selling Arrangement: For earnings revenue a product should have a market and the capability that it can be sold in that market. In this head a brief marketing and selling strategy of the company is given. This head tells us about the company’s distribution network, pricing, promotion etc. which help in assessing whether the company can earn projected profit or not. 6) Manpower Site Organization: This head contains details of various manpower requirements for various activities like general, maintenance, operations and others 7) Risk factors and Mitigating factors: This head contains various risk factors which can pose a threat in the various stages of the activity and it also contains the various mitigating factors or corrective measures which are used to diverse those risks. 8) Project Implementation Schedule: This head gives us a scheduled and tells us about the timeline of when the project will start and its completion time. It also shows us the breakup of each activity in between two dates. It is helpful as it can be known when will actual production start and when inflow of revenue take place. It gives the details of each and every activity along with its date of commencement and its date of completion. 9) Financials: This head contains details like: Project cost: This section contains the cost of the project in details along with the breakup of various cost factors and their percentage weight-age of the total cost.

International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 54

Means of Finance: This head contains the various means of finance used which is either through share capital or term loan. It also contains details like how much of equity and term loan has been raised along with the breakup of how it has been raised and the percentage of each. Sensitivity Analysis: This is another important factor. It is carried out to ascertain the effect of various factors and the change of those factors on the profitability and consequent debt servicing capacity of the company. Profitability Projections: This head consists of the financials i.e. Profit and Loss Account and the Balance Sheet, the important ratios, their assumptions and justifications. It also contains comments on all these financials which helps in getting a clear picture and understanding of the financials of the company. 10) Raw material and consumables: This head provides the details regarding the raw material required and the source from which it will be procured along with the rate per unit. It can also be known whether the company can easily procure raw material from the market and what will be the lead time in procuring it. 11) Common Operating Assumptions: This head contains various details like:a) Cost of repairs and maintenance. b) Percentage of annual escalation on repairs and maintenance. c) Insurance on assets and its rate. d) Cost of utilities. e) Percentage of annual escalation on cost of utilities. f) Amount of salaries and wages. g) Percentage of annual escalation on salaries and wages. h) Amount on administration expense. i) Percentage of annual escalation on administration expense. j) Interest rate on term loan etc. 12) SWOT analysis: The banks generally do a SWOT (strength, weakness, opportunity and threat) analysis to find out the strong or weak points of the project. Banks highlights the things which are good and also the things which are a threat for the project. This is done to see future growth prospectus of the project. 13) General Review: This head tells about the important observations and then gives the comments on those observations. Through this head we can know about the important information like whether there in under or over capacity utilization, whether the production cost can be reduced or not, whether the price and volume calculations taken appear to be reasonable or not, whether there was any delay observed in implementation of International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 55

schedule etc. along with their reasons and comments. It tells us the critical areas and gives comments on those critical areas. It also tells us of the specific issues included in the terms and conditions. 14) Conclusion: This is the concluding part of the report where the senior manager who prepares the report gives the recommendation and his opinion regarding the project so that the person who sanctions the loan can take his decision based on this report. This is a very important part of a TEV analysis because based on this report. This is a very important part of TEV analysis because based on this information the decision of whether to sanction the loan or not depends If the TEV study is satisfactory then the project is approved as technically sound and financially viable. Based on this study any further processing of the sanction of the term loan takes place. If the credit rating is good and the techno-economic viability report is also favourable then the loan proposal is sent to the sanctioning officer for the loan to be sanctioned. It is the sanctioning officer who also after some evaluation finally sanctions the loan amount. SECTION-V: CREDIT RATING REPORT Comprehensive Credit Rating Model for rating borrowers enjoying facilities above Rs. 10 crores (except for trading concerns):

Obligor (Borrower) Rating Borrower’s Position in the Industry Module 2

Borrower’s Financials

Module 3

International business school, Kolkata

Bank of Baroda

Management Quality

Facility Rating

Module 4

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 56

Economy And Industry

Module 1

Done by the Branch Done by CoRC

BOBRAM/ CRISIL Interim Company Rating Report Rating Year Date Model Name Company Code Company’s name Indystry’s name Project Industry’s name Assessed at

Assessed by

Assessment Date

A. Borrower Rating: Score

Previous Rating

Single Scale Rating Meaning Mode Scale Rating Company Rating International business school, Kolkata

Bank of Baroda

Rating

RAROC(%)

Rating Class

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 57

Industry Risk Business Risk Financial Risk Management Risk Facility Rating % Effective LGD

Rating

RAROC(%)

Combined Rating

Score Sheet For the Company (ANNEXURE VI) Risk Entity Name Type: Company Industry Risk There are various parameters under this head out of which 11 compulsory parameters are to be taken and 3 relevant parameters are to be taken from a set of given parameters. Business Risk There are various parameters under this head out of which 6 compulsory parameters are to be taken and 4 relevant parameters are to be taken from a set of given parameters Financial Risk >Past financials Over here all the parameters are compulsory >Future Finanacials Over here all the parameters are compulsory Management Risk There are various parameters under this head out of which 6 compulsory parameters are to be taken and 3 relevant parameters are to be taken from a set of given parameters. Type: Project Construction Risk Funding Risk Project Financial Risk Funding Risk-Project All these 4 sub heading also contain International business school, Kolkata

Bank of Baroda

Valu e

Score

Grade

Srength/Weaknes s

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 58

various parameters which are to be chosen.

CHAPTER - IV

Comparison of Bank of Baroda with Different banks on their credit appraisal Process and their ratio analysis

COMPARISON WITH DIFFERENT BANKS

International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 59

Comparison between Credit Risk Assessment prevalent in different Banks: In the lending operations , the banks are primarily exposed to credit risk. Credit risk is the risk of loss that may occur from the failure of any party to abide by the terms and conditions of any financial contract with the banks, principally the failure to make the required payments on loans due to the bank. Various banks have a structured and standardized credit approval process, which includes a well established procedure of comprehensive credit appraisal. In this context the comparison of the credit risk assessment prevalent in different banks (PSB/Pvt banks/ Foreign Banks) are given below: Bank of India The bank’s board had already approved the following credit risk models, developed by ICRA to rationalize the cost of credit to SME sector by adopting a transparent rating system. The entry level requirements prescribed in this new model would be applicable: a) Large Corporate Model (Domestic/ ECBs/Syndicated Loans) (Fund/Nonfund based limits of Rs.500 Lakhs and above or turnover Rs.5000 lakhs); b) Mid segment Model (Fund/ Nonfundbased limits of Rs.100 lakhs and above not exceeding Rs.500 lakhs and turnover below Rs. 5000 Lakhs); c) SBS/SSI model (Fund/ Nonfund Based limits of Rs.10 lakhs and above but not exceeding Rs.100 lakhs) scoring model); The bank had already adopted rating models a & c above.The model for amounts between Rs.1 crore and Rs.5 crore is under the process of rollout. Allahabad Bank The rating of account may be done under In-House Module or Rating from outside rating Agencies. a) In house Rating Module: The credit exposure wise is applicable as under:International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 60

SL No.

Credit Exposure

Rating Module

1

Upto Rs.10.00 lac

As per CRG-01

2

Above Rs.10 lacs upto Rs.1cr

As per Credit Risk Management Policy of the Bank

3

Above Rs.1 cr to less than Rs.5 cr.

1.Credit Rating Grading-7 (CRG-7A)-Existing Unit

Rs. 5 Cr. & above

RAM-CRISIL Module, If this module is not operationalised, then the following modules will be applicable:

4

2.Credit Rating Grading-7 (CRG-7B)-New Unit

1.Credit Rating Grading-7 (CRG-7A)-Existing Unit 2.Credit Rating Grading-7 (CRG-7B)-New Unit

b) Rating from outside rating Agencies: Allahabad Bank has entered into MOU with CRISIL,ONICRA and SMERA, for getting the SME borrowers rated by them. Axis Bank The Board of Directors establishes the parameters for risk appetite, which is defined quantitatively and qualitatively in accordance with the laid down strategic business plan.This is dovetailed in the process through a combination of governance structures and credit risk policies, control processes and credit systems embedded in a Credit Risk Management Framework (CRMF) .The foundation of CRMF rests on the rating tool. The bank has put in Place the following hierarchical committee structure for credit sanction and review: ➢ Zonal office Credit Committee (ZOCC) ➢ Central Office Credit Committee (COCC) ➢ Committee of Executives (COE) ➢ Senior Management Committee (SME) ➢ Committee of Directors (COD) The bank has developed different rating models for each segment that has distinct risk characteristics viz. Large corporate , MSME, small traders, Financial companies, Micro finance institutions ,project finance etc.

International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 61

Comparison of DATA between four banks: BoB

IDBI bank

ICICI bank

Axis bank

83.96

14.2

36.1

65.78

CAR Ratio

14.36%

11.31%

19.40%

15.80%

Tier I capital

9.20%

6.24%

14%

11.18%

Growth in Advances

21.30%

24%

15%

29.94%

Growth in Deposits

22.40%

49%

17%

20.38%

Net NPA to Net Advances

0.34%

1.02%

1.87%

0.36%

EPS (Rs.)

International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 62

Book Value per share(Rs.)

378.44

Dividend Proposed Provision Coverage Ratio

74.90%

113.1

463

395.99

10%

22%

35%

74.86%

59.50%

72.38%

Comments: Every bank more or less is using the credit rating system associated with external credit rating agencies. ICICI bank divides the responsibility of loan appraisal process among several departments which are more time consuming but less prone to default. Every bank emphasizes on the financial position of the borrower by analyzing the quality of its financial statements, its past financial performance , its financial flexibility in terms of ability to raise capital and its cash flow adequacy, the borrower’s relative market position and operating efficiency .In comparison with other banks, BOB separately measures the risk factors dividing into different segments which are highly justified and appropriate.BOB are holding the advance position in earnings per share other than three banks, that means the market value of BOB share will be high and attractive to the investors. As BOB’s growth in advances and deposits are good besides with CAR ratio 14.36% that means that BOB are utilizing the capital most effectively and efficiently in comparison with other banks. The growth in advances of Axis bank and IDBI bank are good than BOB. There is a huge difference in growth in deposits between IDBI bank and BOB.Net NPA to Net Advances of BOB are very good in comparison with other banks .From the annual reports of BOB we can see that this ratio are gradually decreasing that means the BOB NPA recovery Dept. are performing exceptionally well and from provision coverage ratio we can see that BOB are International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 63

maintaining 74% that means bank’s strategy is not to increase the NPA and not to hamper the financial position in case NPA happens.

CHAPTER - V SEGMENTED RISK MANAGEMENT

Risk Management

Bank of Baroda

NPA Management

Basel Guidelines

International business school, Kolkata

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 64

NPA management: Credit risk management is not NPA management. It is much more than that. NPA management is largely recovery management. It is a situation when default has already taken place. On the other hand credit risk management I concerned more with the quality of credit portfolio before default rather than in the post default situation. Credit risk management mainly consists of: • • • • • • • • • •

Framing of credit policies/credit risk policies Defining corporate philosophy, culture/strategy Setting out risk tolerance levels/benchmark ratios Setting out risk assessment systems Setting up of prudent exposure levels Setting up of risk management organization Risk rating/scoring Loan review mechanism Risk pricing Portfolio reviews

NPA management is the abbreviated form of management of Non Performing Assets, has become a critical Performance area for all the public sector banks. Following are the major reasons for borrowal accounting turning out eventually into non performing assets: ➢ Tardy judicial process > Internal and external diversion of loans funds by the promoters > Time and cost over runs in project implementation > shortage of raw materials > Power shortage > Change in Govt. policies like liberalized imports with lesser incidence of customs duties etc > poor recovery of receivables especially by SSI units with respect to the dues from public sector >Industrial Recession >Failure of the corporate to raise debt / equity from the market , to support bank debt > Business failures >Dishonest management PROVISIONING NORMS: Sub standard Assets

A general provision of 10% on total outstanding should be made without making any allowance for ECGC and value of security.Any unsecured portion of sub standard advances will attract additional

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provision of 10% on outstanding Period for which the advances has Provision Requirement (%) remained in ‘Doubtful’ category Up to 1 year 20 1 to 3 years 30 More than 3 years 100 Loss assets 100% of outstanding amount

Risk adjusted Assets- means degree of credit risk expressed as % weightage have been assigned to balance sheet and off balance sheet items. Value of each asset is to be multiplied with this weighted will produce risk adjusted value of balance sheet and off balance sheet items.RBI has assigned degree of risk to each of the assets of the bank. Broadly it is as under: >Cash and bank balance with RBI 0% >Secured loan to staff 20 %

>with other banks 20 %

>Govt. approved securities 2.5%

>Housing finance to individual 75% (for outstanding upto Rs. 20 Lacs 50%)

> Capital market exposure 125% > Commercial Real Estate 150% Follow up of Advances: The followup of advances Is a small activities starting from the date of disbursement to the date of recovery of last installment/ amount: The important objectives of follow-up of credit facilities: 1. To ensure proper end use of funds. Funds should be used for the purpose, for which these are given.It should not be used for any other purpose. 2. To ensure that the operations of the borrower are on expected lines both physically and financially, 3. To test the assumptions of lending .Advances is granted on the basis of projections. All projections depend on bundle of assumptions. Many of such assumptions can and do wrong .Actual working only shows whether the assumptions have proved correct or not. Most important are capacity utilization, costs incurred, price level. Market conditions etc. 4. To ensure that the terms and conditions are satisfied .While sanctioning the advances, bank stipulates certain conditions to be satisfied, such as restrictions on declaration of dividend, expansion in capacity , or acquisition of fixed assets, repayment of private borrowings etc. 5. To ensure that the securities offered / charged are and continue to be in order .Physical existence , valuation, quality turnover etc. are important. 6. to detect whether any danger signals are developing indicating sickness. Many a time warning signals are thrown up indicating the existence/ emergence of a problem situation. Proper follow up action only can take care of the situation. International business school, Kolkata

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7. To see whether there is any change in management structure, reconstitution, death or resignation of a key person leading to the possible failure of the firm, 8. To examine whether there is any change in the environment affecting the unit, like Govt. policies, Economic situations, crop failures etc. 9. To evaluate the operations of the borrower in a constructive way and to advise/ devise measures for correction/ improvement etc. This will require a total study of the operations, results and trends of the borrower. 10. To formulate future programme / lines of action in the light of the operational results or records. 11. To anticipate problems and reorient plans of action in order to contain such problems effectively. This requires the banker to take a futureistic view of things and advise the borrower suitably.

Willful Defaulter: Based on recommendations of working group on willful defaulter RBI has w.e.f. Mar 2002 instructed as under: The willful Defaulter will broadly cover1. A Borrower who is having adequate resources/ cash flow/ net worth to pay out the dues

but

deliberately not paying the dues, 2. Siphoning of the funds to the detriment of defaulting unit, 3. Non creation of the assets, disposal or misutilization of assets financed, without the knowledge of the bank, 4. Misrepresentation or falsification of records, 5. Fraudulent transactions by the borrower, 6. Where companies within the group has been issued guarantee in favour of the defaulting unit and guarantees are not honoured when invoked , the group will be called willful defaulter, 7. Diversion of the fund to subsidiaries and associate company.This includes routine of fund through another bank other than lending bankers, deploying fund for creation of other assets. Tools available to banks to manage their NPAs

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1. Banks have been advised to devise one time settlement schemes for resolution of NPAs. As per this scheme , for NPA upto Rs. 10 crore the minimum amount that should be recovered should be 100 percent of the outstanding balance in that account.For NPAs over 10 crore the CMDs of the respective banks should personally supervise the settlement of NPAs on a case to case basis. 2.Lok Adalats help banks to settle disputes involving accounts in “doubtful “ and ‘ loss’ category with an outstanding balance of Rs. 5 lakh. 3. Debt Recovery Tribunals (DRTs) were set up under the Recovery of Debts due to Banks and Financial Institutions Act,1993.DRTs have been empowered to decide on cases of advances of Rs. 10 lakh and above. 4. Corporate Debt Restructuring (CDR) applies to outstanding multiple banking accounts / consortium accounts of Rs.20 crore and above. Restructuring of debt through financial restructuring, Business restructuring and operational restructuring. 5. The Govt. enacted SARFAESI Act, 2002 for enforcement of security interest for realisation of dues without the intervention of courts or tribunals.This act enables to strengthen the creditors right of recovery, , speedy NPA recovery, bringing down the level of risk in the system and to empower ARCs (Asset Reconstruction Company) .Benefits of sale of NPAs to ARCs are > enable banks/ FIs to remove NPAs from the loan books > to enable banks/ FIs to focus on their core activities >fuster implementation of resolution strategy by ARCs >Reduces expenditure of banks/ FIs on NPA maintenance.

Cases

One time Lok adalats settlement

DRTs

10262

3524 38969 9467 (source: RBI,report on trend and progress,2008)

181547

SARFAESI act

Others

Basel Committee and Regulations Bank capital plays a very important role in the safety and soundness of individual banks and banking system. Basel Committee for Bank Supervision (BCBS),appointed by Bank for international settlements(BIS), International business school, Kolkata

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has prescribed a set of norms for the capital requirement for the banks in 1988 known as Basel Accord I. These norms ensure that capital should be adequate to absorb unexpected losses or risks involved. If there is higher risk ,then it would be needed to backed up with capital and vice versa. All the countries establish their own guidelines for risk based capital framework known as Capital Adequacy Norms. Capital Adequacy measures the strength of the bank. Capital Adequacy Ratio is also known as Capital Risk Weighted Assets Ratio(CRAR) .In India this risk based capital standard came into force in 1992-93. Basel II is the revised capital accord of Basel I. Basel II accord is a broad spectrum of risk management. The Basel II is more risk sensitive in capital allocation which not only includes credit risk but the market and operational risks as well. Banks are capable of applying more risk sensitive methodologies through Basel II norms. This structure is based on three reinforcing pillars which together are expected to contribute to the safety and soundness of the financial system which is shown and described below:-

3 PILLARS OF BASEL II

MINIMUM CAPITAL REQUIREMENT

SUPERVISORY REVIEW PROCESS

MARKET DISCIPLINE

First pillar: Minimum Capital Requirement: 1) Capital allocation that is more sensitive to risks. 2) Alignment of regulatory and economic capital. •

•

3) Encouragement of better risk management techniques. Financial stability depends upon the first pillar. Banks with adequate capital is the most important level of defense for a central bank.

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Urges banks to:Maintain adequate capital in relation to their risks Monitor measure and manage their risks by developing better risk management techniques Take into consideration risks that are not defined under pillar I such as, market risk, liquidity risk Third pillar: Market discipline Better information disclosure Enhanced efficiency of financial markets Credit Risk Rating – Basel Committee Norms Internal ratings based approach recommended by the basel committee would form the basis for a sophisticated risk management system for banks. A key element of the basel committee’s proposed new capital accord is the use of a bank’s internal credit risk ratings to calculate the minimum regulatory capital it would need to set aside for credit risk. Called the internal ratings based approach It links capital adequacy to the assets in a bank’s books. Compared to capital allocation based on the standardized approach (including the one-size fits all old version), the IRB regime is likely to make regulatory capital more consistent with economic capital (the capital required by a bank to cover unexpected losses, as an insurance against insolvency). This is likely to reduce the amount of regulatory capital banks will be required to set against credit risk inherent transactions and portfolios. Based on its risk assessment, a bank will slot the exposure within a given grade. There must be enough credit grades in a bank’s internal ratings system to achieve a fine distinction of the default risk of the various counter-parties. A risk rating system must have a minimum of six to nine grades for performing borrowers and a minimum of two grades for non-performing borrowers. More granularity can enhance a bank’s ability to analyse its portfolio risk position, more appropriately price low-risk borrowers in the highly competitive corporate lending market and importantly, prudently allocate risk capital to the non-investment grade assets where the range of default rates is of a large magnitude. The credit risk of an exposure over a given horizon involves the probability of default (PD) and the fraction of the exposure value that is likely to be lost in t he event of default or loss given default (LGD). While the PD is associated with the borrower, the LGD depends on the structure of the facility. The product of PD and LGD is the Expected Loss (EL). Risk tends to increase non-linearly – default rates are low for the least risky grades but rise rapidly as the grade worsens – an A grade corporate will have a less probability of defaulting within one year, while the next rated (BBB) borrower will have higher probability of defaulting, which may further be higher for a CCC rated borrower. The probability of default is what defines International business school, Kolkata

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the objective risk characteristics of the rating. A bank’s rating system must have two dimensions. The first must be oriented to the risk of the borrower default. The second dimension will take into account transaction specific factors. This requirement may be taken care of by a facility rating which factors in borrower and transaction characteristics or by an explicit quantifiable LGD rating dimension. For the purpose, banks will need to estimate facility-specific LGD by capturing data on historical recoveries effected by them in the various assets that have default. The recoveries will have to be adjusted for all expenses incurred and discounted to the present value at the time the corporate default. Clarity and consistency in the implementation of the bank-wide rating system is integral to a bank to relate its credit scores to objective loss statistics and convince the regulator that its internal rating system is suitable for calculating regulatory capital. Human judgment is central to the assignment of a rating. Banks, therefore, should design the operating flow of the process towards promoting accuracy and consistency of ratings, without hindering the exercise of judgment. While designing the operating framework, banks should include the organizational division of responsibility of rating the nature of reviews to detect errors and inconsistencies, the location of ultimate authority over rating assignment, the role of models in the rating process and the specificity of rating definitions. Banks must have a mechanism of bank testing the rating system and the loss characteristics of their internal ratings. This is essential to evaluate the accuracy and consistency of the rating criteria, accurately price assets and analyse profitability and performance of the portfolio, monitor the structure and migration of the loan portfolio and provide an input to credit risk models and economic capital allocation process. The PD will allow the back testing of bank’s rating system by comparing the actual default performance of entities in a particular grade to the rate of default predicted by the bank rating. Back testing against internal data and benchmarking the performance of the internals ratings system against external rating systems will be a key part of the general verification process. There are certain limitations, however, in using such an external mapping. First, would be the significant difference in the quality and composition of the population of corporate rated by rating agencies and those in a bank’s portfolio. Second, would be the time lag in which the agencies would be putting out their data on default probabilities/migration frequencies – with this time lag there is a likelihood that the adverse changes in default probabilities is factored into the rating system well after a recession in the economy. Third, there would be potential inconsistencies in mapping a point-in-time rating with a Through-the-cycle rating fourth, statistics available relate to developed markets and emerging markets and do not reflect representation of varying degree of economic reforms and globalization. International business school, Kolkata

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Any improved internal risk internal rating system will need to have operational for some time before either the bank or the regulators can amass data needed to back test the system and gain confidence in it. The Basel paper on the IRB approach states that bank will be required to collect and store substantial historical data on borrower default, rating decisions, rating histories, rating migration, information used to assign the ratings, the model that assigned the ratings, PD histories, key borrower characteristics and facility information. Banks seeking eligibility for the IRB approach should move to develop and warehouse their own historical loss experience data. Although data constraints remain a challenge and data collection is costly, many banks have recognized its importance and have begun projects to build databases of loan characteristics and loss experience. The internal rating of a bank is not just a tool for judicious selection of credit at business unit level. Thanks to rapid developments taking place worldwide in a risk management practices, internal ratings are being put to uses that are more progressive. Internal ratings are used as a basis for economic capital allocation decision at the portfolio level and the individual asset level. Having allocated this capital and in vie of the average risk of default assumed by the bank, the bank needs to appropriately price the asset to compensate for the risk through a risk premium and also generate the required shareholder return on the economic capital at stake. Construction and validation of a robust internal credit risk rating system is just the first step toward sophisticated credit risk management. For an ambitious bank, the bank the IRB approach promoted by Basel will form the platform for the risk management measures that are more sophisticated such as risk based performance measurement.

Drivers of effective credit risk management: Basel II was highlighted as one of the main drivers in shaping the banks’ approach to credit risk management. It imposes disciplinary capital charges for procedural errors, limit violations and other operational risks. It also creates new pressures to ensure that effective credit risk management controls are in place. A leading investment bank, for example, commented that regulations drive its credit risk management procedures. The bank is forced to provide more detailed disclosures in its annual reports. These may include information on its strategies, nature of credit risk in its activities and how credit risk arises in those activities, as well as information on how it manages credit risk. Basel II will affect a number of key elements in another European bank, including a more rigorous assessment of the bank’s credit risk appetite, more technical approach toward its counterparties and better portfolio risk management. Another bank mentioned that the impact of Basel II is largely dependent on the environment it is regulated under, as it is different for each region. In one U.S. bank, regulatory pressures raise the status of the risk group, while in another, these pressures can distract from strategic business projects. While regulatory compliance is indeed a significant International business school, Kolkata

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driver, most banks’ credit risk management aspirations span beyond this. Key players also seek to gain competitive advantage through effective credit risk management. The objective of best practices in credit risk management is to provide comprehensive guidance to better address credit risk management. The findings from Lepus' survey illustrate that credit risk management practices differ among banks, as they are dependent upon the nature and complexity of an individual bank’s credit activities. Sound practices should generally address the following areas: 1) Establishing an appropriate credit risk environment. 2) Operating under a sound credit-granting process. 3) Maintaining an appropriate credit administration, measurement and monitoring process. 4) Ensuring adequate controls over credit risk. The feedback from banks demonstrates that centralization, standardization, consolidation, timeliness, active portfolio management and efficient tools for exposures are the key best practice in credit risk management. A Tier One American bank is considering having more efficient tools for “what if” analysis and tools to provide transparency to the business. This is particularly important for counterparty exposure at a firm wide level. Another U.S. institution is focusing on stress testing, concentration risk, macro hedges and capital risk market management. Moreover, the firm has consolidated market risk and credit risk. In 25 percent of the interviewed banks, achieving best practice involves having an active portfolio management in the lending book along with real-time credit risk management. A leading investment bank identifies best practice as having good quality data, for example, identifying processes that induce data errors. Timeliness is another contributing factor. Real-time pre-deal checking, effective credit limits management and country risk management are key to good credit risk practice at another bank. However, this is largely dependent on the market the bank is targeting.

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Risk Management of Bank of Baroda Bank of Baroda has a robust and integrated Risk Management system to ensure that the risks assumed by it are within the defined risk appetites and are adequately compensated.. Bank has constituted a Sub Committee of the Board on ALM (Asset Liability Management) and Risk management to assist the Board on financial risk related issues. The Bank has a full fledged Risk Management Department headed by a General Manager and consisting of a team of qualified, trained and experienced employees. The Bank has set up separate committees, of Top Executives of the Bank to supervise respective risk management functions as under. Asset Liability Management Committee (ALCO) is basically responsible for the management of Market Risk and Balance Sheet Management. It has the responsibility of managing deposit rates, lending rates, spreads, transfer pricing, etc in line with the guidelines of Reserve Bank of India. It also plans out strategies to meet asst-liability mismatches. Credit Policy Committee (CPC) has the responsibility to formulate and International business school, Kolkata

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implement various enterprise-wide credit risk strategies including lending policies and also to monitor Bank’s credit risk management functions on a regular basis. Operational Risk Management Committee (ORMC) has the responsibility of mitigation of operational risk by creation and maintenance of an explicit operational risk management process. Risk management policy: The Bank has Board approved policies and procedures in place to measure, manage and mitigate various risks that the Bank is exposed to. In order to provide ready reference and guidance to the various functionaries of the Risk Management System in the Bank, the Bank has in place Asset Liability Management and Group Risk Policy, Domestic Loan Policy, Mid Office Policy, Off Balance Sheet Exposure Policy (domestic), Business Continuity Planning Policy, Pillar III Disclosure Policy, Stress Test Policy and Stress Test Framework, Operational Risk Management Policy, Internal Capital Adequacy Assessment Process (ICAAP), Credit Risk Mitigation and Collateral Management Policy duly approved by the Board. Bank’s compliance with Basel II The Bank has a very large overseas presence amongst the Indian banks and has implemented the Basel-II Guidelines from 31st March 2008. In keeping with the guidelines of the Reserve Bank of India, the Bank has adopted Standardized Approach for Credit Risk, Basic Indicator Approach for Operational Risk, and Standardized Duration Approach for Market Risk for computing the capital adequacy ratio. The Bank has, therefore, been computing the Capital to Risk Weighted Assets Ratio (CRAR) on parallel basis under Basel-I and Basel-II Guidelines. The Bank is also providing additional capital towards Operational Risk under Basel II guidelines. The CRAR of the Bank is summarized as under:

In compliance with the Pillar–II guidelines of the Reserve Bank of India under Basel II framework, the Bank formulated its Policy of Internal Capital Adequacy Assessment Process (ICAAP) to assess internal capital in relation to various risks the Bank is exposed to. Stress Testing and scenario analysis are used to assess the financial and management capability of the Bank to continue to operate effectively under exceptional but plausible conditions. Such conditions may arise from economic, legal, political, environmental and social International business school, Kolkata

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factors The Bank has a Board approved Stress Testing Policy describing various techniques used to gauge their potential vulnerability and the Bank’s capacity to sustain such vulnerability. The Bank conducted its ICAAP tests on semiannual frequency along with stress tests as per the ICAAP Policy of the Bank.

Data presentation & Data Analysis A) Comparison between the total outstanding credit exposure The following table exhibits the total outstanding credit exposure(fund based + non fund based ) of Bank of Baroda during the following months: Credit Rating

31-10-2009

OUTSTANDING AS ON (Rs. In crore) 30-11-2009 31-12-2009 31-01-2010

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28-02-2010

31-03-2010

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BOB-1 BOB-2 BOB-3 BOB-4 BOB-5 BOB-6 BOB-7 BOB-8 BOB-9 BOB-10 Total

132.37 353.63 577.32 905.07 1095.89 44.40 30.56 0.00 0.00 0.00 3139.26

137.93 344,04 683.73 995.16 1049.18 82.78 30.41 0.00 0.00 0.00 3323.23

142.57 326.71 780.58 1046.55 1091.14 70.48 65.31 0.00 0.00 0.00 3523.34

142.57 355.86 812.25 1101.48 1078.82 89.49 34.78 0.00 0.00 0.00 3615.25

156.04 305.55 721.23 987.40 1102.50 87.57 51.62 0.00 0.00 0.00 3411.85

156.74 292.01 572.87 642.05 1230.31 118.50 57.55 0.00 0.00 0.00 3070.03

Comments In BOB-1 category there is a increasing trend right from the beginning. There is a sharp decline in BOB-3 category after January,2010.The low risk category have got their highest point after a momentum growth in January,2010.The outstanding amount in BOB-2 category has also declining trend in 2010. The outstanding amount of loan in the medium risk category has increased for BOB-4 category from October 09 to January 2010 and then a sharp decline is noticed. In BOB-5 category there is a sharp increase from Jan 10 till march,10. BOB-6 category has a slight increase in the exposure. There has been a lesser amount of exposure in the high risk category.Only BOB-7 has some negligible amount of outstanding. B) Comparison between Large Borrower Advances (10 crore and above) of the Kolkata Metro Region (KMR) with that of the Eastern Zone Dated 31-10-2009 30-11-2009 31-12-2009 31-01-2010 28-02-2010

Total Advances EZ(Rs.crore) 3323.23 3523.34 3615.25 3411.85 3070.03

in Total Advances in KMR(Rs % of advances in KMR out crore) of total EZ 3080.91 92.71 3261.82 92.57 3238.92 89.59 3012.99 88.31 2821.11 91.89

Comment: On an average around 92 % of the total large borrower advances in the Eastern Zone are contributed by the KMR during this period. C) Comparison between the outstanding credit exposures ( Fund based & Non fund based ). (Amount in crores) Outstanding Exposures 31.03.2008 31.03.2009 FB NFB FB NFB BOB-1 27.52 0.13 99.82 0.28 International business school, Kolkata Credit Rating

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BOB-2 BOB-3 BOB-4 BOB-5 BOB-6 BOB-7 BOB-8 BOB-9 BOB-10 TOTAL

117.26 281.22 867.70 193.08 30.62 0.00 22.65 0.00 0.00 1540.05

41.21 134.30 114.10 292.65 9.18 0.00 0.00 0.00 0.00 591.57

82.23 214.74 333.90 1150.51 22.85 15.03 0.00 0.00 0.000 1919.08

308.20 265.57 260.71 121.56 0.00 1.29 0.00 0.00 0.00 957.61

Comments: The analysis shows that the larger borrower accounts are graded mostly between BOB-2 & BOB5.( investment grade high safety and investment grade moderate safety). D) Comparison between the exposures in various segments The advances or a credit exposure of a bank constitutes a large part of its assets. The following table exhibits the net advances of Bank of Baroda during 6 months:

Dates 31-10-2009 30-11-2009 31-12-2009 31-01-2010 28-02-2010 31-03-2010

Wholesale (Rs. In crore) 2389.01 2563.62 2734.78 2734.78 2550.06 2380.17

Advances SME Others (Rs. In crore) (Rs.in crore) 551.94 198.31 583.62 175.99 611.53 177.03 585.50 292.72 540.61 321.18 528.17 161.69

Net Advances (Rs. In Crore) 3139.26 3323.23 3523.34 3615.25 3411.85 3070.03

% increase in Net Advances --5.86 6.02 2.61 (5.63) (10.02)

Comments Wholesale sector holds the maximum net advances. The net advances of BoB have increased till 2009.But then there is a decline. On an average wholesale sector holds 76%, SME holds 18% and other holds the rest 6% of total net advances.

Limitations: International business school, Kolkata

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1) Less time duration: It is very difficult to get knowledge about such an important and huge domain of banking sector in two months. 2) Conservativeness: From the bank’s perspective, sometimes it is very difficult to get the data and information due to the maintenance of the secrecy of the customers profile and Bank itself. Future Challenges of risk management of Indian Banking industry

Risk management activities will be more pronounced in future banking because of liberalization, deregulation, and global integration of financial markets. This would be adding depth and dimension to the banking risks, As the risks are correlated, exposure to one risk may lead to another risk, therefore management of risks in a proactive, integrated and efficient manner will be the strength of the successful banks. The forward looking banks would be in process of placing their MIS for the collection of the data required for the calculation of PD, LGD and EAD. The banks are expected to have at a minimum PD data for five years and LGD and EAD data for seven years. Presently most Indian banks do not possess the data .Also the personal skills, the IT infrastructure and MIS at the banks need to be upgraded substantially if the banks want to migrate to the IRB approach. Development of MIS, Human Resource,, proper risk based pricing in the increased competition from

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foreign banks and domestic banks, maintaining the Basel II norms and CAR are going to be the future challenges of the risk management of Indian Banking Industry.

CASE STUDY

CHAPTER - VI

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Case study M/S XYZ Ltd. Business experience of directors: The directors hails from business family and are attached with several business. Sri Keshav Chand Padia and Sri Bijay Padia are also associated with Jaraikela Lumberman (India) Pvt. Ltd. engaged in similar type of business and have acquired sufficient experience in the line of manufacturing of plastic containers, PVC pipes and other plastic products for industrial uses. Background of the company: The company was originally promoted by Sri Biswanath Kedia and others in the name of M/S Bala Shah Industries Ltd, which was incorporated on 2nd July, 1997 and the certificate for commencement of business was obtained on 15th July, ’97. The company was incorporated with the main object to carry on the business as timber merchant, Shaw mill, Vencer and plywood manufacturer etc. on 9 th Dec ’97, the company purchase land measuring 1.62 acres (98 kottahs) of P.S. Bhadreswar, Mouza – Bighati, Dist – Hooghly with a total consideration of Rs. 7.13 lacs. Factory shed was constructed during 98-99 for which 20.13 lacs was invested. The main objects of the company were changed to carry on the business of manufacturing and dealing all kind of plastic materials. The name of the company was also subsequently changed to M/S Eastern Polycraft Industies Ltd. on 13th July ’99. Under the initiative of the new promoters the company took initiative for setting up of a plastic container manufacturing unit with a total cost of Rs. 195.38 lacs by availing financial assistance from BOB, Brabourne Rd. Branch. The company was initially sanctioned a term loan limit of Rs. 134.95 lacs to part finance the cost of the project. The commercial production was to start from 2000-2001. Though The company installed one machine as against two originally planned the production could not be started effectively due to defect found in the moulds. Though several attempts were made to repair the moulds it could not be repaired. As a result the sales of the company failed to pick-up as projected. The company postponed the idea of purchasing the second machine, out of the loan of Rs. 134.95 lacs. Sanctioned to the company. They only availed loan upto Rs. 72.33lacs. Rest of the limit was surrendered. Subsequently during 2002-2003 the company purchased new International business school, Kolkata

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moulds. Their product were approved by various major oil and paint companies and their sales started peaking up. The company there after went for manufacturing of containers with one injection moulding machine in the year April,2000. The company continuously improve its performance and added additional capacity by way of purchase of new machines. The company is regular in repayment of loan installment of bank. Encouraged by success and looking at increasing demand the company has now decided to go for further expansion of capacity of their concerning division.

Marketability: Main users of the products (moulded plastic containers) manufactured by the company are as under:Indian oil Corporation Ltd. Dainippon Inks and chemicals India Ltd. HPCL BPCL IBP Co. Ltd. etc. Major suppliers of basic raw material (plastic granules and master batch) are as under:Haldia Petro Chemical Ltd. India Petro Chemical Ltd. Reliance Industries Ltd. etc. Security Coverage: Sr. No. 1 2 3 4 5

Particulars of Fixed Security Hypothecation of Plant &Machinery of the Company as per ABS as on 31.3.13 (WDV) Fresh addition of Plant & Machinery for the proposed fresh project (Term Loan) Equitable mortgage of factory, land and building at Dobapukur Addition of proposed factory shed & building as per the fresh project (term loan) Equitable mortgage of 32 units of SDF flats at Uluberia

International business school, Kolkata

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Existing

Proposed

373.06

373.06

-

490.5

175.48

175.48

-

110.00

86.56

86.56

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 82

6 7 8 9 13 13

Fresh addition of 6 units of SDF flats at Uluberia for which fresh term loan is requested Equitable mortgage of immovable property in the name of Mr. Bijay Padia situated at Rishati Total fixed security Proposed exposure (net of margin) Security Coverage (No. of times) Fixed Assets Coverage Ratio (FA/TL)

-

22.5

20.00

20.00

655.10 842.49 0.78 1.90

1378.10 1539.42 0.83 1.58

Scope for additional collateral securities:Scope for further collateral securities was explored but it is informed that at present the company does not have any further security to be offered as collateral security.  Further there has been substantial appreciation in the cost of immovable prospectus mortgaged/to be mortgaged with the bank for which re-valuation has not been sought for.  Also, stocks & book debts will be available as primary security & monitoring control will be better, as monthly stocks / book-debts statements to be submitted by the company.  Financial Parameters & Assessment of Financial Performance Particulars 2008-09 2009-10 2010-11 2011-12 2012-13 Audited Audited Audited Projected Projected a) B/S Data: Share capital General Reserve Share application money Accumulated surplus Tangible Networth Term Liabilities Capital Employed Net Block Funds invested outside business Current Assets (-) Current Liabilities Net Current Assets Capital deployed

b) Operational Data: Net Sales Other operating income Total Operating income Other income International business school, Kolkata

Bank of Baroda

240.5 1.00 88.16 329.66 251.01 581.67 572.78 24.74 579.74 596.58 (-16.85) 580.67

241.5 25.00 101.27 370.77 928.55 1299.32 1148.57 3.74 983.42 836.42 147.00 1299.32

266.5 25.00 131.8 423.3 784.94 1208.24 977.18 3.74 1329.88 1102.56 227.32 1208.24

291.5 240.39 531.89 602.71 1134.6 837.91 3.74 1533.76 1240.82 292.94 1134.6

291.5 398.39 690.45 429.68 1120.13 722.81 3.74 1705.3 1311.73 393.57 1120.15

1409.2 1409.2

2554.27 2554.27

3975.78 3975.78

4699.72 4699.72

5110.34 5110.34

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 83

Manufacturing expenses Administration, Selling expenses Miscellaneous expenses Depreciation Interest Net Profit before Tax Net Profit after Tax

c) Important Ratio: Net Profit/Net Sales (%) PAT/TNW (%) Operating Profit margin Net Profit/ Capital Employed Stock Turnover ratio

Debtor Turnover ratio Creditors Holding level Current ratio CR (without considering installment liabilities as CL) Debt-Equity ratio (TTL/TNW) Debt-Equity ratio (TOL/TNW)

60.71 1243.7 54.99 0.93 74.76 76.89 18.63 11.78

67.27 2226.23 92.42 0.54 139.25 132.21 30.9 15.57

1.5 3429.76 144.71 171.39 184.24 47.18 27.53

1.75 4055.16 170.93 139.27 168.88 167.23 108.59

2.00 4418.27 185.4 115.10 151.91 241.66 158.56

0.84 3.57 16.05 2.03 61

0.61 4.2 15.48 1.20 46

0.69 6.5 13.77 2.28 43

2.31 20.42 13.77 9.57 43

3.13 22.96 13.75 14.16 43

60 48 0.97 1.08

76 57 1.18 1.33

61 56 1.21 1.37

61 56 1.24 1.38

61 57 1.3 1.43

0.76 2.57

2.50 4.76

1.85 4.46

1.13 3.47

0.62 2.52

Notes: - Manufacturing expenses includes raw material, power and fuel, other manufacturing expenses. Administration & selling expenses includes sales promotion & publicity, salaries & wages and other admin expenses. Whether Fund flow statement submitted: Yes Summary

2008-09

2009-10

2010-11

2011-12

2012-13

Long term sources

215.56

948.39

223.92

247.86

273

Less: Long term uses

251.34

722.04

110.24

182.23

182.23

Surplus(+)/ Shortfall(-)

(35.78)

226.35

113.68

65.63

91.43

International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 84

Short term sources

214.13

177.33

232.78

138.25

80.11

Less: Short term uses

178.32

403.68

346.46

203.88

171.54

Surplus(+)/ Shortfall(-)

35.78

(226.35)

(133.68)

(65.63)

(91.43)

As seen from the table above, there is no diversion of short term fund for long purposes except during 08-09, the amount being Rs. 35.78 lacs which is a meager amount considering the scale of operation? Here it may also be mentioned that the company had purchased machinery worth Rs. 28.39 lacs from own source for which reimbursement was sought. As the term-loan was sanctioned on 29.4.09, subsequent to which term-loan was disbursed, there has been a mismatch in the fund flow during 08-09, which has been rectified. Comments on performance:- Sales: Sales of the company is showing increasing trend. The company has achieved Gross Sales of Rs. 1649.99 lacs and Net sales of Rs. 1513.20 lacs during the last FY 08-09 against the earlier estimated gross sales of Rs. 1664.00 lacs and estimated Net sales of Rs. 1532.81 lacs thereby achieving 99.16% of the Gross sales and 98.36% of the Net sales. The variance is negligible and is hence accepted. During the course the company registered growth in Gross sales by 54.81% and in Net sales by 54.54% against the previous year (PY)07-08 Sales when the Gross sales of the company was Rs. 1385.85 lacs and Net sales was Rs. 913.84 lacs. During the Current year (CY) the company has already registered Gross sales of Rs. 1308.25 during the period 1.4.09 to 20.8.09. The company also has orders worth Rs. 3347.36 lacs from various respected companies as on date, the break-up of which is as under:-

International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 85

Sr. No.

Company’s Name

Amount (Rs.)

1

Indian Oil Corporation Ltd. (Kolkata)

1005.43

2

Indian Oil Corporation Ltd. (Malda)

314.89

3

Indian Oil Corporation Ltd. (Delhi)

81.70

4

Indian Oil Corporation Ltd. (Allahabad)

237.85

5

Hindustan Petroleum Corporation Ltd. (Kolkata)

605.72

6

Balmer Lawrie & co. Ltd.

392.77

7

DIC India Ltd. (Kolkata)

208.53

8

Bharat Petroleum Corporation Ltd.

143.86

9

Waxpol Industries Ltd.(Ranchi)

32.11

13

Tide water oil Co. Ltd. (Kolkata)

212.63

13

Seacem Paints India Pvt. Ltd.

42.66

13

Vibjore Paints

5.89

15

Fujima Paints

19.06

15

Cico Technologies Ltd.

21.31

15

Managalam Lubricants

22.94

(Rs. in lacs)

TOTAL

3347.35

The company gets continuous work order from IOC Ltd., IBP Co. Ltd., HP Corporation. Ltd., etc. The company has now estimated/ projected gross sales of Rs. 2640.61 lacs / Rs. 4131.20 lacs during 08-09/ 09-10 which seem to be reasonable and acceptable under normal business conditions due to the under mentioned reasons:Past record of the company is satisfactory. Sales during the current year till date are reasonable.

International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 86

Present orders in hand and the continuous orders received by the company from reputed companies, due to the expertise and product quality of the company. The company has proposed for expansions / increase in capacities of the existing manufacturing unit during the year which will increase the production level of the company. Cost of the raw material / consumables have increased, the cost of which will be passed onto the customers, thereby increasing the value of the product. Increase in demand of the product due to improvement in the domestic economy. The company has also projected Gross sales of Rs. 4859.36 lacs, Rs. 5283.43 lacs & Rs. 5697.05 lacs during 2010-11,11-12,12-13 respectively which seems to be reasonable and acceptable under normal conditions. Net Profit: The company had earlier earned NP of Rs. 30.46 lacs during the year 07-08 with NP margin of 4.22% and operating profit margin of 20.52%. However as per the ABS as on 31.3.08 the NP of the company reduced to Rs. 10.23 lacs during 07-08 registering Net profit margin of 1.13% & operating profit margin of 18.21%. The main reason for the reduced profit is explained as increase in the cost of sales, owing to increase in the price of the raw materials. Besides there was an increase in selling & administration expense and interest paid to bank expenses. The company had earlier also estimates NP of Rs. 32.37 lacs during 08-09 but as per ABS as on 31-3-09 the NP registered by the company is Rs. 13.78 lacs, while recording NP margin of 0.84% and the operating profit margin of 16.05%. Reduced operating profit is explained by the company is due to procurement of raw materials by the company on the basis of delivery challans, (credit purchase) during 08-09, but the relevant bills for which was submitted by the suppliers to the company for payment during the FY 08-09. Reduction in the NP margin during 08-09 is due to increase in the selling & administration expenses (main components being – trading expenses, truck expenses & discount allowed to customers) and interest paid to bank on account of increase in bank exposure obtained for the expansion project of the company. In continuation of the above trend the company has estimated as conservative NP for the FY 08-09 at Rs. 15.57 lacs while working out the operating profit margin at 15.48% and NP margin at 0.61% which is acceptable. The company has projected NP of Rs.27.53 lacs, Rs. 108.59 lacs, Rs. 158.56 lacs & Rs. 206.92 lacs for the FYs 08-09, 09-10, 10-11, and 11-12 respectively. T he operating profit margin for the future projection works out in the range of 13 – 14% while the NP margin has been projected to increase ranging from 2.31% to 4.78% mainly due to stable increase in the selling & administration expenses, while the bank interested has been projected to reduce on a/c of repayment of the term loans availed/ to be availed which seems to be reasonable and is acceptable. Net worth The NW of the co has increased gradually due to plough bach of profit into the business as well as due to fresh introduction of equity. The tangible network of the company as per ABS as on 31.08.09 has increased to Rs 329.66 has as against Rs 272.27 lacs as on 31.3.08 mainly due to fresh introduction of equity of Rs 49.00 lacs. International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 87

The TWW of the Co. has been estimated at Rs 370.77 Lacs for the current financial year 09 – 10 due to further introduction of capital.

Movement of tangible Net Worth of the company is tabled below: (figs. in lacs) Particulars

2008-09

2009-10

2010-11

2011-12

2012-13

Opening TNW

272.27

329.66

370.77

423.30

531.89

(+) PAT/ Loss

11.78

15.57

27.53

108.59

158.56

(+) Increase in Equity

49.00

1.00

25.00

25.00

-

Increase/Decrease in (3.00) share application money

(24.00)

-

(25.00)

-

Increase/Decrease share premium

-

-

-

-

0.54

-

-

-

Adjust: Previous year expenses Increase/Decrease in General Reserve

-

-

-

-

-

-

-

-

Increase/Decrease in deferred tax liability Closing TNW

-

-

-

-

-

329.66

370.77

423.3

531.89

690.45

Adjust: Assets

in -

Intangible (0.45)

International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 88

Ratios Current Ratio CR of the Company as on 31.3.09 reduced to 0.97 from 1.04 as on 31.03.08 mainly due to increase in short term bank borrowings, of the term loan installment liabilities are not considered as part of current liabilities then the CR daily 08 -09 and 09- 10 works out to 1.16 and 1.03 respectively. The Company has estimated CR of 1.18 during the current year 09- 10. Here again if the term loan installment liabilities are not considered as part of CL then the CR works out to 1.33 which is acceptable. The Company being a medium enterprise as per circular no – Bcc/ BR / 2005 of SME policy, CR of 1.20 is acceptable, CR for the future projection have been worked out above the benchmark level and the same is acceptable.

Debt Equity Ratio: TTL / TNW of the company as on 31.3.09 is 0.76 which is estimated to increase to 2.5 as on 31.03.09 on a/c of increase in term loan expense availed/ to be availed from the bank, but the same is within the acceptable benchmark level. TTl/ TNW in the future preparation is projected to improve gradually due to repayment of the term loan installment. Similarly, TOL / TNW of the company, was 2.57 as on 31.3.09 which is estimated to increase to 4.76 on a/c of increase in bank exposer TOL/ TNW in the future preparation has been projected to increase due to repayment of the term loan installments. Assessment of Working Capital: Last assessment on what sales and for which year proposed: Last assessed based on projected sales of Rs.1715.62 lacs for the FY 2009-10. Whether company has achieved last accepted sales, if not, reasons: The Financial Year 09-10 is not yet over and hence achievement of the projected sales does not arise. However the company’s total earnings for the year 2008-09 as per ABS as on 31.3.09 is Rs 1469.99 lacs against the earlier estimated revenue of Rs.1428.02 lacs. Net sales / Export achieved up to the date of assessment / half yearly / quarterly sales: Company has achieved sales of Rs. 1007.25 lacs during the current financial year from 1.4.09 to 20.8.09. Method of Lending: 1st method of lending / Turnover method. International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 89

Working Capital term loan (if any): NIL Justification for Working capital: As per guidelines, working capital limit has been worked out on the basis of 1st method lending as well as turnover method as per table given here under –

Working Capital Assessment for the company as a whole: (figs. in lacs) Method of MPBF (Maximum Permissible Bank Finance)

Actual (Rs.)31.3. 08

Actual (Rs.)31.3. 09

Estimated (Rs.)31.3. 10

Estimated (Rs.)31.3. 11

Total Current Assets Less: Current Liabilities (other than bank borrowings) Working Capital gap Minimum stipulated margin 25% of Working capital gap Actual/Projected NWC MBPF Current ratio

401.43 167.53

579.74 238.07

983.43 476.43

1329.87 702.55

233.9 58.48

341.67 85.42

507.00 126.75

627.32 156.83

17.07 175.42 1.04

(16.85) 256.25 0.97

147.00 360.00 1.18

227.32 400.00 1.21

Assessment of working capital under PBF method: International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 90

Particulars Actual/Projected turnover Gross Working capital (25% of actual turnover) Minimum margin: 5% turnover Actual/Projected Net Working capital Percentage of NWC to Actual turnover PBF (Permissible Bank Finance) Percentage of PBF turnover

31.3.08 912.59 228.15

31.3.09 1409.2 352.30

31.3.10 2554.27 638.57

31.3.11 3975.78 993.95

45.63 17.08

70.46 (16.85)

127.71 147.00

198.79 227.32

1.87%

(1.20%)

5.76%

5.72%

182.52 20.00%

281.84 20.00%

491.57 19.25%

766.63 19.28%

The company has requested for review of cash credit limit at the existing level of Rs.360.00 lacs for the FY 2010-11 which is justified under 1ST method of lending as well as Turnover method and the same is proposed for sanction. Comments on inventory holding/creditors/debtors level/ reasons for accepting large variance in inventory/creditors/ debtors level. (figs in days) Particulars Stock Turnover Ratio Debtors Turnover Ratio Creditors Holding Level

31.3.08 52 83

31.3.09 61 60

31.3.10 46 76

31.3.11 43 61

31.3.12 43 61

31.3.13 43 61

42

48

57

56

56

57

Inventory Holding level: The inventory holding during 08-09 increased to 61 days from 52 days during 07-08. It has however been explained by the company that the increase in holding level is due to increase in the cost of raw materials (plastic granules) towards the end of FY 08-09 and not on account of holding of higher level of inventory. However the holding level is at acceptable level. The company has estimated/projected the holding level in the range of 42-46 days which is reasonable and acceptable. Debtors holding level: The main customers of the company are the Navaratna PSU oil companies and other big reputed companies. It has been observed in the past that payment for the same is received within 2-3 months of sales. However the holding level of the company improved from 83 days during 2007-08 to 60 days during 08 -09. The debtors level has been estimated at 76 days for the current year 09-10 and projected to stabilize at 61 days in the future which is reasonable and acceptable. Creditors holding level: International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 91

Major portions of the company’s creditors are the creditors under Letter of Credit. The creditor’s level of the company has increased from 42 days during 07-08 to 48 days during 08-09 due to increase in letter of credit exposure the creditors level has been further estimated/projected to increase and stabilize in range of 56-57 days on account of the letter of credit exposure , but the same is reasonable and adaptable Term loan: Demand for the company’s product is encouraging. In order to the situation in the company has envisaged carrying out expansion of its production capacity. The company has therefore approached the bank to part finance the cost of the expansion of the project. The total cost of the expansion project has been estimated at Rs 623.00lacs by the company. The company has requested for fresh term loan of Rs 490.5lacs to part finance the proposed expansion project whereas the promoter’s contribution will be 25% of the total project cost. The breakup of the cost of the project and mean of finance is given hereunder.

Total cost of the expansion as per the project report submitted by the company will be as under: PROJECT COST Sl. no. 1 2 3

Particulars Factory shed & building @ Rs. 550/sq. ft. (20000 for the existing unit at Bhadreswar, Hooghly) New SDF flats allotted at Uluberia industrial growth centre (6 nos. of flats @ Rs. 3.75 lacs) Plant & Machinery ( for both the units at Bhaleswar and Uluberia) Total project cost

Sl. no.

MEANS OF FINANCE

Rs. in Lacs Total Cost 110.00 22.5 490.5 623.00

Amount (Rs.)

1

Term Loan form Bank

467.00

2

Promoters Contribution

156.00 Total

International business school, Kolkata

Bank of Baroda

623.00

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 92

Project Debt Equity

2.99

As requested by the company we have recommend for waiving of TEV study as it is only an expansion project and the company is in this line of activity since long and is also having satisfactory dealing with BOB.

BASIS OF ESTIMATION FOR COST OF PROJECT: 1) Factory shed & Building – The said cost has been estimated based on the offer for civil construction work from M/S ABC Commerce & Construction Company Pvt. Ltd., as ISO 9001:2000 certified company having its office at 5A, Orient Row, Kolkata-700017, vide their offer letter No. AMCON/CIVIL/SG-131/513 dated 4.6.09. The breakup of the civil construction cost is as under:Total area = 108M X 17M = 1836 sq. M

Sl. no.

Description of work

Uni t

Qty

Unit Rate

Total Amount (Rs.)

1

Earth work in excavation

M3

797

180

143460

2

Silver sand filling

M3

2750

590

1622500

3

B.F.S

M2

2268

190

430920

4

P.C.C. (1:3:6)

M3

259

3950

1023050

5

R.C.C. (1:1.5:3)

M3

447

5150

2302050

6

Brick work (250 thk)

M3

308

3460

1065680

7

Plastering (Avg. 15mm – 1:6)

M2

2400

175

8

Reinforcement steel for floor (TMT Bars) Shuttering

MT

50

52000

M2

680

240

163200

13 Flooring IPS (40 MM thk) International business school, Kolkata

M2

1836

210

385560

9

Bank of Baroda

420000 2600000

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 93

13

Damp proof (25 mm thk)

M2

63

180

11340

13

M2

250

710

177500

15

Plinth protection toiling & 25 mm I.P.S. Surface Drain

RM

258

1975

509550

15

Earth work in filling

M3

543

95

TOTAL

51585 10906395

2) 6 new SDF Flats: The Company has now been further offered 6 nos. of SDF buildings by WBIIDC based on the merit of the project. The SDF flats are adjacent to the recently acquired 32 SDF flats at Uluberia Growth Centre. The Company has informed that the said buildings will initially be acquired by the Company from own sources and thereafter sanctions of the Term loan, the Company will seek for reimbursement of the same. The cost of each flat has been informed to be 3.75 lacs each as per the project report. Based on the above information and the project report submitted by the company, Debt Service Coverage Ratio (DSCR) has been calculated as under:-

The DSCR of the company as a whole has been worked out as under: Particulars Service: PAT (+)Interest on Term loan (+)Depreciation & Preliminary expenses written off (A) Total Debt: Interest on Term loan (+)Installments on Term loan (B) Total DSCR (A/B) Average DSCR International business school, Kolkata

Bank of Baroda

09-10

10-11

11-12

12-13

15.57 62.21 139.25

27.53 106.24 171.39

108.59 88.88 139.27

158.56 69.71 115.30

217.03

305.16

336.74

343.37

62.21 36.37 98.58 2.20 2.2/4

106.24 98.87 205.11 1.49 1.49/4

88.88 132.23 221.11 1.52 1.52/4

69.71 132.23 201.94 1.70 1.70/4

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 94

As per Domestic Loan Policy Guidelines 2008. Average DSCR of – with a minimum DSCR of 1.25 in any given year is acceptable.

SENSITIVITY ANALYSIS: Based on various situations sensitivity analysis has been carried out, the summary of which is as per chart given below:Sensitivity Factors

2% drop in selling price

DSCR for various years 08-09

09-10

10-11

11-12

1.68

1.10

1.19

1.40

1.14

1.25

1.29

1.41

Average DSCR 2% increase in operating cost

1.34 1.73

Average DSCR 10% drop in capacity utilization Average DSCR

International business school, Kolkata

Bank of Baroda

1.14 1.315

1.95

1.31 1.49

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 95

The above sensitivity analysis shows that the operations of the company are satisfactory and is not very susceptible to the various scenarios we can see from the above table that all parameters of project are comfortable enough to withstand adverse variations even in critical situation. Moreover, the company is dealing in supply of its product to public sector oil companies so chances of drop in sale price more than 2% is a remote possibility. Assessment of Non-Fund Limits: Bank Guaranties – Bank Guaranties are required by the company for uninterrupted supply of module plastic containers to IOCL, HPCL, and in lieu of security deposit to be submitted favouring WBSEB. All these guarantees are performance in nature. The present outstanding balance in the BG Limit is Rs. 40.29 lacs. Normally, Bank Guarantees issued on behalf of the company have not been invoked in the past except for the instance the 3 BGs aggregating Rs. 8.37 lacs were invoked by BSNL during 05-06 due to non-execution of supply orders of polythene pipes as there was some dispute over specification and cost of materials. However, the same was adjusted in full through the cash credit account of the company and hence no crystallization for the same was made. The company has now requested for review with increase of the BG Limit from Rs.50 to Rs. 60 lacs at 25%. We propose increase in the BG Limit from Rs.50.00 lacs to Rs. 60.00 lacs at 25% margin as the company has not any further collaterals for the increase in exposure. Assessment of the BG Limit is as under: -

(figs. in lacs) Particulars Present outstanding BGs Less: Amount of BG to expire during the next 12 months Sub total Add: Estimated requirement of BGs during the next 12 months for participation in various tenders. Add: Estimated requirement of BGs for submitting to WBSEDCL in lieu of the security deposit. Estimated requirement of BG Limit for the next 12 months Say, (whole figure) BG Limit requested by the company BG Limit recommended for sanction. International business school, Kolkata

Bank of Baroda

Amount (Rs.) 40.29 15.00 25.29 20.00 15.00 60.29 60.00 60.00 60.00

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 96

Considering the turnover projected by the company, the above assessed BG Limit is justified.

Inland / import letter of credit (period not to exceed 180 days) – Letter of credit facility is required by the company for procurement of raw material. Raw material is procured by the company from the domestic as well as the international market as per requirement. The company is presently enjoying inland / imports LC Limit of Rs. 50.00 lacs present outstanding of which is Rs. 48.96 lacs as on date. Cash margin for the said facility has been reduced from 25% to 10% by the GM(EZ) as per modification proposal dated 2.7.09. The company has also been sanction Ad-Hoc inland / Import LC Limit of Rs. 64.00 lacs at a cash margin of Rs.64.00 lacs at a cash margin of 10% by the DGM (KMR) on 3.7.09 for 3 months due to increase in the cost of plastic granules and basic raw materials. Ad-Hoc limit was also required due to short supply of the raw materials, while there are huge work orders received for which sufficient raw materials holdings is required. The o/s Balance of the Ad-Hoc inland / import LC Limit is Rs. 66.43 lacs as on date, (excess of Rs. 1.43 lacs has been opened against 100% cash margin). Due to regular expansion measures adopted by the company owing to increased demand of the product, the company envisages enhanced requirement of raw materials procurement under LC. The company has therefore requested for increase in the regular LC Limit from the existing level of Rs. 50.00 lacs to Rs. 325.00 lacs. On sanction of the regular LC Limit of Rs.325.00 lacs the Ad-Hoc LC Limit of Rs.64.00 lacs is proposed to be regularized and the o/s balance of the same will form part of the proposal enhanced regular LC Limit of Rs. 325.00 lacs. Out f the total raw material procured by the company, 85% of the raw material procurement is made under LC. Based on the above estimations / projections submitted by the company LC Limit has been assumed as under:(Figs. in lacs) Total consumption of raw material for 09-10 Consumption of raw material under Letter of credit (being 85% of the raw material consumption) Raw material purchased under LC Usance period Lead period Total usance time LC requirement – 1800.15 x 70/365 LC Limit requested by the company LC Limit proposed for sanction

International business school, Kolkata

Bank of Baroda

2000.17 1700.14 1800.15 55 days 15 days 70 days 326.05 325.00 325.00

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 97

SWOT Analysis: Strength: 1) The company is an existing profit making unit. 2) The sales of the company are on the increase which is satisfactory. 3) The promoters are well experienced in the trade. 4) Production of the company is of high quality and has the approval of oil sector companies. 5) The company has been awarded ISO 9001-2000 certification, approval renewed by NQAQSR is Dec ’07. Weakness: 1) Low margin of profit but the same is proposed to improve due to the proposed expansion profit. 2) The price of basic raw materials i.e. HDPE granules is subject to fluctuating being a petro product but the same is at a manageable level.

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 98

Opportunities: 1) With the opening of economy and privatization of Government sector oil companies; there is vast scope of increase of demand of companies’ product. Threat: 1) Competition from other manufactures which can be managed by the company due to its expertise in the field, reputation built in the market and the standing of the promoter in the market.

CHAPTER - VII

FINDINGS AND RECOMMANDATIONS

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Summary of Research Findings & Suggestions

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 99

Summary of Research Findings (based on data available) The net large borrower advances of Bank of Baroda in the Eastern Zone have increased over the period. The advances include loans to wholesale sector, SME sector and others. The SME lending has a declining trend. More than 63% of the funds allocated to the large borrower advances have been given to medium risk category of borrowers (especially BOB-5).Fund based exposures are high. Approximately 34% of the funds have been provided to the low risk category of borrowers.

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 100

Study reveals that the KMR alone accounts for more than 88% of the large borrower advances in the Eastern Zone. Efforts were also made to improve the speed of decision making. The average turnaround time for sanction of a proposal was reduced considerably to less than 30 days during FY10 as against 45 days during FY09. With the continued thrust on faster delivery through efficient channels and adoption of better practices in credit administration, the Bank plans to reduce the turnaround time in according a sanction further to less than 20-25 days. The number of Fast-track proposals sanctioned during FY10 was 230 amounting to Rs 32,933.23 crore compared to 122 amounting to Rs 16,525.99 crore last year. The strengthening of fast track clearance of large credit helped in brining qualitative change in the credit dispensation. The internal rating methodology of the bank reliable and it is reviewed from time to time. While following the internal rating process, the bank also considers the rating given by the other professional rating agencies whenever possible in order to avoid risk.

LIMITATION Making the credit rating comparison is not possible with its competitors, the major players like HDFC Bank, IDBI Bank, Axis Bank, ICICI Bank, Nationalized Banks like SBI, Bank of India, and Allahabad Bank etc. are taken into consideration, because of inadequate data. These financial institutions have been selected because these are the major players in today’s market. An analysis with these players will help to know better the reason why they are standing at front or at back Bank of Baroda.

Recommendations/ suggestions The other two regions except KMR are not properly explored by the bank. Therefore the strategy for the bank should be more and more financial inclusion in those unexplored parts of the region.

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 101

Some of the parameters under the head Industry risk and Business risk are compulsory and some are optional. These affect the overall rating of any company. If the credit rating are intentionally or neglectfully done, some good company will be deprived of good rating as well as good facility and some company are upgraded wrongly. So, this optional rating parameters should be omitted/ avoided to rectify the errors. For any International Company and export-import based company the rating procedure or system should be different from domestic ones, any international credit rating system should be adopted taking into consideration the international factors. SME sectors should be priorities. The SMEs sector is considered to be an untapped market for financial institutions in India. We just need to combat certain obstacles. emphasis is given on credit monitoring in the following ways: As a part of the intensive monitoring system, slippages of accounts into NPA category are being restrained by identifying stressed assets periodically. In addition, SIDBI has designed a system of identification of trigger points to help Regional Offices and Branch offices to contain individual accounts from slippage into NPA category along with an indicative list of early warning signals. It has set up well defined distribution of monitoring responsibilities required at Branch level, Zonal level and at Head Office depending on loan size and monitoring. It has set up default review committees at branch and zonal offices to review all direct finance cases at monthly intervals. . Finally, it has established a system of study of ‘failure-cause analysis” in respect of fresh NPA cases for Taking preventive measures. NPA in Commercial Banks have gone up to an alarming level, most of it caused due to restructuring of loans to the Real estate and Textile sector. CRISIL just came up with a paid rating service for real estate projects. The key objective of CRISIL real estate star rating is to empower consumers. They will also fill a gap by providing credible verified information on projects. CRISIL Star rating is an attempt to empower consumers in their investment decisions. Consequently, quality projects and developers will be able to differentiate themselves more efficiently. This will leads to branding in real estate industry. If Bank of Baroda adopts some special credit rating system for these two sectors, then NPA can be minimized.

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 102

CONCLUSION

CHAPTER VIII

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 103

Conclusion: Credit risk is the biggest risk which a bank faces and can arise through many facets of banking operations. Credit risk management has acquired a greater significance in the recent past for various reasons. Topmost among them is the financial liberalization across the globe and on-going economic reforms, which has changed the complexion of the markets. The post liberalization years have put significant pressure on banks in India with many banks showing signs of distress, only reason is lack of effective credit risk management systems. With increase in new segments of risks, the need is felt for credit risk management techniques with more sophisticated and versatile instruments for risk assessment, monitoring and controlling risk exposure. The guidance note issued by the RBI is a comprehensive document in which the RBI has identified further steps which are required to be taken by banks for upgrading their risk management systems. The systems, procedures and tools prescribed in the guidance note are, therefore, only indicative in nature and risk management systems in banks should be adaptable to changes in business size, the market dynamics and the introduction of innovative products by banks in future. As per the views expressed in the note, with the adoption of new Accord, banks will require substantial up gradation of the existing credit risk management systems and to adopt suitable credit risk / risk rating models to meet the requirement of credit risk management and risk based pricing. While selecting or developing the model the prevailing conditions end commonly acceptable framework for the banking system as a whole need to be kept in view. As lack of availability of proper MIS/representative data is one of the main problems, suitable models for collection and analysis of data will also have to be developed. Banks may adopt any model depending on their size, complexity, risk bearing capacity and risk appetite etc. which should, at least, achieve the following: Result in differentiating the degree of credit risk in different credit exposures of a bank; Identify concentrations in a portfolio; Identify problem credits before they become NPAs; Identify adequacy/inadequacy of loan provisions; Help in pricing of credit.

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 104

Bibliography 1) Annual Report of Bank of Baroda, 2) Internal Circulars of Bank of Baroda 3) RBI guidelines note-credit risk 4) Risk management in Banks: Role of rating agencies Websites 1) www.bankofbaroda.com 2) www.icai.com 3) www.creditriskmeasurement.com 4) www.crisil.com 5) www.rbi.org.in 6) Different pdf files

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 105

ANNEXURE-I Facility Rating Grades and Definition: Grade no. I II III IV V VI VII VIII

Nature of Grade FR-1 FR-2 FR-3 FR-4 FR-5 FR-6 FR-7 FR-8

Description Highest Safety Higher Safety High Safety Adequate Safety Reasonable Safety Moderate Safety Low safety Lowest Safety/Clean loans/ Totally Unsecured

ANNEXURE II Composite Rating Grades and Definition: Grade No.

Nature of Grade

Definition of Conposite / Combined Grades

I II III IV V VI VII VIII IX X

CR-1 CR-2 CR-3 CR-4 CR-5 CR-6 CR-7 CR-8 CR-9 CR-10

Minimum (lowest) Expected Loss Lower expected Loss Low Expected Loss Reasonable Expected Loss Adequate Coverable expected loss Moderate Expected loss Extra Expected Loss High Probability of loss Higher probability of loss Highest Expected Loss

International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 106

ANNEXURE-III A) Borrowers /obligors eligible for rating under LCM, Banks, NBFCs, Broker Models, infrastructure project under operations phase and expansion / diversification projects in case of existing companies Large Corporate Model / Bank Model / NBFC Model: From score

To score

Grade

Above 8.5 Above 7.5 Above 6.5 Above 5.75 Above 5.0 Above 4.25 Above 3.5 Above 2.5 Above 1.5 0

10.0 8.5 7.5 6.5 5.75 5.0 4.25 3.5 2.5 1.5

I II III IV V VI VII VIII IX X

To score

Grade

Common Scale BOB-1 BOB-2 BOB-3 BOB-4 BOB-5 BOB-6 BOB-7 BOB-8 BOB-9 BOB-10

Broker model From score

Above 8.5 10.0 Above 7.5 8.5 Above 6.5 7.5 Above 5.75 6.5 Above 5.0 5.75 Above 4.25 5.0 International business school, Kolkata

Bank of Baroda

I II III IV V VI

Common Scale BOB-3 BOB-4 BOB-5 BOB-5 BOB-5 BOB-6

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 107

Above 3.5 Above 2.5 Above 1.5 0

4.25 3.5 2.5 1.5

VII VIII IX X

BOB-7 BOB-8 BOB-9 BOB-10

B) Borrowers / obligors eligible for rating under SME (Manufacturing)/ SME (Services) and Trader Models in case of existing companies:

SME(Manufacturing) / SME (Services) / Trader Model : From score

To score

Grade

Above 8.5 Above 7.5 Above 6.5 Above 5.75 Above 5.0 Above 4.25 Above 3.5 Above 2.5 Above 1.5 0

10.0 8.5 7.5 6.5 5.75 5.0 4.25 3.5 2.5 1.5

I II III IV V VI VII VIII IX X

Common Scale BOB-3 BOB-4 BOB-5 BOB-5 BOB-6 BOB-7 BOB-7 BOB-8 BOB-9 BOB-10

C) Project Borrowers / Obligors eligible for rating under Infrastructure (Build phase) / and Green Field projects (LCM/ SME): Large corporate Model (with Project): From Score

To score

Grade

Common Scale

Above 4.5 Above 3.5 Above 2.5

5 4.5 3.5

BOBPR-1 BOBPR-2 BOBPR-3

BOB-6 BOB-7 BOB-8

International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 108

Above 1.5 0

2.5 1.5

BOBPR-4 BOBPR-5

BOB-9 BOB-10

SME (Mfg / Services) Model (with Project): From Score

To score

Grade

Common Scale

Above 7 Above 5 Above 3 Above 1 0

8 7 5 3 1

BOBPR-1 BOBPR-2 BOBPR-3 BOBPR-4 BOBPR-5

BOB-6 BOB-7 BOB-8 BOB-9 BOB-10

Infrastructure (Power/ port/Road/Telecom ) Model- Build Phase: From Score

To score

Grade

Common Scale

Above 4.5 Above 3.5 Above 2.5 Above 1.5 0

5 4.5 3.5 2.5 1.5

BOBPR-1 BOBPR-2 BOBPR-3 BOBPR-4 BOBPR-5

BOB-6 BOB-7 BOB-8 BOB-9 BOB-10

ANNEXURE IV APPRAISAL NOTE TO

DEPUTY

GM,

BOB

KOLKATA

METRO REGION

Name of the account Branch Region Zone

SECTION 1 :DETAILS OF THE PROPOSAL 1) Gist of the proposal::1.1) a)Takeover with enhancement / fresh/increase/short review/ for 12 months b) last review on:c) Reason for short Review:1.2) Increase/ decrease in fund based and non fund based limits: International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 109

Particulars

Existing

Proposed

1.3) Sanction /Modification : a) Modification: b) Concessions: Confirmations: C)(Reference of existing sanction) Date Authority Due Date of Review 2) Basic Data Asset Classification Bank’s credit Rating External Credit Rating Constitution Date of establishment Location (Registered office) Factory Group Industry and nature of Activity Exposure to industry a) Sectoral Cap for industry b) Bank’s exposure c) zone’s exposure d) NPA(bank)/(Zone) Collaboration/Joint venture if any Dealing with the bank since MPBF Our bank’s share Rate of interest a) working capital limits Term loan Security available Average drawings during the year a) term loan b)working capital Yield in the account Major inspection irregularities Internal audit Concurrent audit Statutory audit International business school, Kolkata

Bank of Baroda

Primary: Collateral: Additional:

Increase

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 110

Credit audit Auditors of the company Qualification remarks of the auditors as on Pollution clearance Whether statutory dues have been paid Whether names of the company / associates or Directors appear in RBI’s defaulter’s list/caution list Whether company/ firm/ promoters and associates on ECGC caution list/ special approvals list Compliance for earlier sanctioned terms

2.01) Banking Arrangements Name of the bank

Fund based Existing

Non fund based

% share Amount Proposed Existing

% share Amount Proposed Existing Proposed Existing

Proposed

Note: Consortium Rules 2.02) Loans from Financial Institutions Name of the institution

Limit

Present outstanding

Excess/overdue

Security

2.03) security/WDV of security to be mentioned: 2.04) Any reschedulement agreed (in last 3 years): 2.05) Name of the Directors/ partners: 2.06) Key person: 2.07) Name of the guarantors

Net worth as on

2.08) Business experience of directors/ partners: 2.09) Share holding pattern as on: Particulars International business school, Kolkata

Bank of Baroda

No. of shares

Amount

%

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 111

A)1.a.Indian Promoters b.Foreign Promoters 1. persons acting in concert Sub total B) FIs/Banks/MFs C) Public D) Others TOTAL

3.0) Issue for consideration:3.1) Take over with enhancement….. Nature of facilities

Existing limits

Term finance: F.B. N.F.B. Working capital: cash credit Working capital:Demand loan Total fund Based Non Fund Based: Inland/Import L/CS DA/DP (capital goods/raw materials) Inland/Foreign guarantees (performance/Financial) Total Nonfund based

International business school, Kolkata

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Proposed limits

Present outstanding

Excess/ overdues if any

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 112

TOTAL EXPOSURE Note: break up of over dues Interest on credit facilities(WC/TL) Development of bills under LOC Packing Credit overdues Bill purchased Foreign bill purchased not realized Ad hoc limit not adjusted

Note: 3.2) Modification in terms and conditions: 3.3) Concession: 3.4)Confirmation: 4.0) Back ground of Company:5.0) Security Coverage:Facility

(Rs. In Crs.) Limit

Security Primary Collateral Additional

Note: International business school, Kolkata

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Value

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 113

6.0) Terms and conditions: 7.0) Other information: 8.0) Justification: 9.0) Branch Recommendations: 10.0) Proposal Received at:a) Branch

b) Region:

c) Zone:

if any delay Reason may be indicated.

ANNEXURE V : FINANCIAL PARAMETERS AND ASSESSMENT 1.0) Financial performance:c) snap shot of balance sheet for the last 2 years and estimate/projections for next 2 years d) Operational data (Rs. In lacs) Particulars 2009-10 2010-11 2011-12 2012-13 2013-14 a)balance sheet/ Capital Structure Projected Projected Projected Projected Projected Paid up capital c.Equity Share capital d.Preference share capital International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 114

Reserve and surplus (excluding Revaluation reserves and net of intangible assets) Tangible net worth Term liabilities Capital employed Net block Funds invested outside business Current Assets Current Liabilities Net Current Assets b) Operational Data Gross Sales Less, Excise/ sales tax Net sales Of which exports Other Income Manufacturing Expenses Adm & Selling Exps. Depreciation Interest Net profit before Tax Net profit after Tax Dividend Profitability Ratio(Net profit/sales) Net profit/ capital employed(%) Stock Turnover ratio Debtor turnover ratio PAT/ TNW(%) Current ratio D/E ratio (total term liabilities/ TNW excluding revaluation reserve) D/E ratio (total outside liabilities/ TNW without revaluation reserve) Note:

Movement of TNW: Particulars Opening TNW Add, PAT Add, Increase in Equity/ share premium/ Share application money Add/ substract: change in intangible assets Adjust- Prior year expenses (deferred tax) International business school, Kolkata

Bank of Baroda

31.03.06

(Rs. In lacs) 31.03.07 31.03.08

31.03.09

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 115

Deduct – dividend payment Any other item- deferred tax Closing TNW Comments: 2.0 Comments on performance: Sales/Receipts: Profits: Net worth: Ratios: Balance Sheet: 3.0) Assessment of Working Capital:Last assessment on what sales and for which year proposed: Whether company has achieved last accepted sales; if not reasons: Net sales/ Export achieved upto the date of assessment / half yearly/ quarterly sales: (Rs. In lacs) Particulars Audited Estimated Projected (31.3.07) (31.03.08) (31.03.08) 1. Current Assets 2.Other Current liabilities 3.Working Capital Gap (1-2) 4.Actual/ projected bank borrowing 5.Total current liabilities(2+4) 6.25% of total current assets(1) 7.Actual / projected NWC 8.Minimum stipulated margin (6 or 7 whichever is higher) 9.Maximum Permissible Bank Finance(MPBF) (3-8) 10.Actual/ projected bank borrowing 11.Excess Borrowing, if any (8-7) Comments on inventory holding/ creditors/debtor’s level/reasons for accepting large variance n inventory/ creditors/ debtors level Particulars Ind.Raw materials Imp.Raw materials Stock in process Finished goods Receivables Receivables-Export Creditors Comments:

31.03.07

3.1) Requirement of other facilities:International business school, Kolkata

Bank of Baroda

31.03.08

31.03.09

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 116

• • • •

Term loan requirements: (in case of term loan mention name of the project appraisal agency) (projected and cash flow as per annexure) D.P.Guarantee: B.D.(IDBI) limits: Cost and means of finance-whether appraisal done by any financial Institution/ our project Finance Dept. whether full tie up is made. A) Proposal B)Project/Purpose:

Project cost: S NO.

Particulars

Total Cost Total

DSCR calculation: Particulars Cash Accurals Interest payable of term loan Term loan repayment DSCR Average DSCR

Year1

Year2

Year3

Year4

Year5

3.2) Assessment of Non Fund Based Limits: Letter of credit Doc.LC (inland/Foreign)

-----Sight /DA (days) ----- For Capital Goods ----- For raw materials

Note: Calculation of LC requirement to be given taking into account consumption of raw materials – imported / indigenous- lead period- credit available et. Assessment of Bank guarantee: • Purpose • Calculation of requirement • Existing outstanding • Fresh guarantees requirements • Advance payment/ financial guarantee • Invocations of guarantee,if any 3.3) Any other matter which in the opinion of branch / zone is important to decide the proposal:

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 117

CMA Format SME INPUT Value in lacs BASIC INFORMATION Please Enter Data in Blue Coloured Cell Last year of audited/ provisional 2007 results Company Code Name of the company Industry (as per ASCROM Other industry classification) Currency INR Auditors 2005 2006 2007 2008 2009 Year ended (DD-Mon-YYYY) 31.03.2005 31.03.2006 31.03.2007 31.03.2008 31.03.2009 No. of Months 12 12 12 12 Exchange Rate PROFIT & LOSS ACCOUNT INPUT Gross Sales -Domestic -Export Sub Total (Gross Sales ) Less Excise Duty Net sales

0.00 0.00

0.00 0.00 0.00

0.00

0.00 0.00 0.00

0.00 0.00

0.00 0.00 0.00

0.00 0.00

0.00 0.00 0.00

0.00 0.00

0.00 0.00

0.00

0.00

% wise rise/fall in net sales as compared to previous year Other Operating income Export incentives Duty Drawback Others Total operating income

0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.000

0.00 0.00 0.00 0.00

0.00

Cost of sales Raw materials consumed i) imported ii) Indigenous

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

Other spares consumed i) imported ii) indigenous

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

Power and fuel Direct labour and wages Other manufacturing exps.

0.00 0.00 0.00

0.00

0.00

0.00

0.00

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 118

Depreciation Sub total

0.00

Add, Op. stock of WIP Less, Cl stock of WIP Total cost of Production

0.00 0.00

0.00

0.00 0.00 0.00

0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00

0.00

0.00

0.00

Add, Op. stock of Finished Goods Less, Cl. Stock of Finished Goods Total cost of sales

0.00 0.00

Selling ,Gen & Administration Exps

0.00

Cost of sales + SGA

0.00

0.00

0.00

0.00

0.00

Operating profit before interest Interest payment to banks Interest –WC Interest –term loans Interest payment to FIs Interest- WC Interest- term loans Total interest

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00 0.00 0.00 0.00

Operating profit after interest Non operating Items Add, non operating Income Profit on sale of assets/ investments Investments and Dividend Forex gains Non-op. income from subsidiaries Tax Refund Other Non operating Income Total non operating Income Deduct Non Operating expenses Loss on sale of assets Prelinimary exps. W/ off Other non operating exps. Total Non operating Exps.

0.00

0.00

0.00

0.00

0.00

0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00

0.00

0.00

0.00

0.00

Net of Non-Operating income/ Expenses

0.00

0.00

0.00

0.00

0.00

Profit Before Interest Depreciation & Taxes (PBIDT)

0.00

0.00

0.00

0.00

0.00

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 119

Profit before Tax

0.00

0.00

0.00

0.00

0.00

Provision for Taxation Current Deferred Total : Provision For Taxation

0.00

0.00

0.00

0.00

0.00

Net profit after Tax

0.00

0.00

0.00

0.00

0.00

Extraodinary Items adjustments Extraodinary Items adjustments(+) Extraodinary Items adjustments(-) Sub total Extra ordinary items

0.00

0.00

0.00

0.00

0.00

Adjusted PAT (excl Extraodinary items) Dividend Paid On Equity Capital On Preference Sh.Capital Dividend Tax Partner’s withdrawal Dividend(%) Retained Profit Cash Accruals BALANCE SHEET (LIABILITIES ) iNPUT CURRENT LIABILITIES Short term borrowings from banks (including bills purchased, discounted & excess borrowings placed on repayment basis) Bank Borrowings-from our bank Bank borrowings –from other banks Sub total Short term borrowings from Associates & group concerns Short term borrowings from others Creditors for purchases Advances / payments from customers / deposits from dealers

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00 0.00

Provisions -Tax International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 120

-Others Dividend payable Statutory liabilities due with in one year Installments of term loans /Deferred payment credits/Debentures/deposits/ redeemable preference shares (due within one year )- to banks Deposits Other current liabilities due within one year Total Current Liabilities Term Liabilities Debentures Preference share capital Dealer’s Deposit Deferred tax liability Term loans- from Banks Term Loans- from FIs Term Deposits Borrowings from subsidiaries /Affiliiates (Quasi Equity) Unsecured Loans (Quasi Equity)

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00

0.00

0.00

0.00

0.00

Total Term Liabilities

0.00

0.00

0.00

0.00

0.00

TOTAL OUTSIDE LIABILITIES

0.00

0.00

0.00

0.00

0.00

NET WORTH Equity share capital Share capital (Paid up) Share Application (finalized for allotment) Sub Total (share capital)

0.00 0.00

General Reserve Revaluation Reserve Partner’s capital/ proprietor’s capital

0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00

Other reserves & surplus: Share premium Capital subsidy Others Balance in P& l Account (+/-)

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00

International business school, Kolkata

Bank of Baroda

0.00 0.00 0.00

0.00 .0.00 0.00

0.00 0.00 0.00

0.00

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 121

Net Worth

0.00

0.00

0.00 0.00

TOTAL LIABILITIES

0.00

0.00

0.00

0.00 0.00

0.00

BALANCE SHEET(ASSETS) INPUT CURRENT ASSETS Cash and bank balances

0.00

0.00

0.00

0.00

0.00

Investments Govt. and other trustee securities Fixed Deposits with Banks others

0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

Deferred receivable (due within one 0.00 year)

0.00

0.00

0.00

0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

Receivables Receivables other than Deferred & exports (Domestic) Export Receivables Note: 1.All receivables upto 180 days only to be included. 2.Sale bills negotiated underLC to be excluded.

Inventory Raw materials -imported Raw materials –Indigenous Work in process Finished goods (incl Traded Goods) Other consumable spares-Imported Other consumable sparesindigenous Sub total (inventory)

0.00 0.00 0.00

0.00

0.00

0.00

0.00

Advances to suppliers

0.00

0.00

0.00

0.00

0.00

Advance payment of tax

0.00

0.00

0.00

0.00

0.00

Other Current Assets

0.00

0.00

0.00

0.00

0.00

TOTAL CURRENT ASSETS

0.00

FIXED ASSETS International business school, Kolkata

Bank of Baroda

0.00

0.00

0.00

0.00

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 122

Gross Block Less,Accumulated Depreciation Net Block

0.00 0.00

Capital Work in progress

0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00. 0.00

Deferred Tax Asset

0.00

0.00

0.00

0.00

0.00

Other Non-current assets (incld. Dues from directors)

0.00

0.00

0.00

0.00

0.00

NON CURRENT ASSETS Investments/ book debts/ advances/ deposits (which are not current assets) Investment in group concerns Loans to group concerns/ advances to subsidiaries Investment in others Advances to suppliers of capital goods and contractors Deferred receivables(maturity exceeding one year) Debtors > 6 months Others (loans & advances non current in nature,ICD’s etc)

TOTAL NON CURRENT ASSETS Intangible assets: Goodwill. Patents, & trademarks Accumulated losses, Prelinimary expenses, Miscellaneous expenditure not w/off, Other deferred revenue expenses

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

TOTAL ASSETS

0.00

0.00

0.00

0.00

0.00

TANGIBLE NETWORTH

0.00

0.00

0.00

0.00

0.00

DIFFERENCE IN B/S

0.00

0.00

0.00

0.00

0.00

Net working capital Current Ratio TOL/TNW

0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00

ADDITIONAL INFORMATION Arrears of depreciation International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 123

CONTINGENT LIABILITIES Arrears of cumulative Dividends Guarantees issued(relating to business)/(for group companies) Graturity liability not provided for Disputed excise/ customs/ tax liability LCs All other contingent liabilities (incld. Bills purchased – under LC) Installments of term loans/Deferred payment credits/Debentures/deposits (due within one year) Preference share capital (due in less than a year)

ANNEXURE-VI 1.For the illustrative purpose , a complete set of parameters which are to be scored under different modules for large corporate model (LCM) listed as under.However, during the rating process only selected parametersdepending upon the industry characteristic would appear for scoring. 2. For other models SME (Mfg), SME (Services), Trader ,Banks,NBFCs Infrastructure projects etc separate set of parameters are to be scored and the same are available in details at the relevant model descriptions uploaded at the risk management page of our bank’s internet: MODULE NAME RISK PARAMETERS MODULE-I (Industry risk) (score provided by risk management , BCC) Industry Characteristics

Demand –Supply Gap Government Policies Extent of Compettiton Input related risks Industry Financials Return on Capital Employed: industry Operating margin –Industry Growth in operating margin- industry Variability of operating margin- Industry MODULE-II (Business Risk) (Parameters selection by Risk Management,BCC) Indigenization level Integration of operations Multi- locational advantage Selling Cost Operating Efficiency Employee Cost Capacity Utilization Availability of raw materials Energy Cost Access to cost effective technology

International business school, Kolkata

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ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 124

Market Position

Raw materials Usage Management of price volatility Product design and development Adherence to environmental regulation R& D activities FDA/ MCA approved plants Efficiency of beneficiation process Availability of skilled labour Hygienic processing facility Brand Equity Customization of products Project management skills Diversified Markets Replacement Markets After sales service Proximity to market Long term contracts/Assured off take Distribution setup Financial ability to withstand price competition Access to patents Consistency of quality Product range

MODULE –III (Financial Risk)

Past Financials

Future Financials

ROCE PAT/ Net sales Total Outside Liabilities/ Total Net worth Net Cash Accruals / Total Debt Current Ratio Accounting Quality Interest Coverage DSCR Net worth Contingent Liabilities Management of foreign exchange and fund reputation risk Interest Coverage PAT/ Net sales Net cash Accruals / Total debt Total Outside liabilities / Total Networth ROCE DSCR Effectiveness of projection Current Ratio Net Worth

Financial Flexibility Ability to raise Debt Ability to raise Equity MODULE – IV (Management Risk) Track record Payment Record

International business school, Kolkata

Bank of Baroda

Ability to raise debt from Banks / Financial Institutions Ability to raise debt from Market Ability to raise equity from own source Ability to raise equity from Capital Market Ability to meet profit projection Ability to meet sales projection Past Payment Record

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 125 Quality of information submitted by the company Working Capital management Management Quality Corporate Governance Experience in the industry Managerial Competence Business and Financial policy Management proactiveness Group support Other Factors Strategic Initiatives Management Successions Labour Relations Company with Project (Industry & Business Risks are taken from Obligor Rating and not evaluated separately) Project Implementation Risk –PIR Expected Balance Project Duration Stabilization Construction Risk-PIR Project Complexity Clearances Expected time overrun Funding Risk- PIR

Financial Flexibility Financial Closure

MODULE - III FINANCIAL RISK 1. Upload the basic input CMA data sheets / templates provided duly approved by the credit officer / branch Manager. 2. The following financial rations are calculated automatically and the final Financial Risk score for the company is computed and gets integrated with the final Rating. Financial Risk is evaluated through a combination of the following ratios (both past & projected): Interest Coverage Return on Capital Employed PAT / Net Sales DSCR Total Debt /Tangible Net worth Net cash accruals / Total debt Current Ratio Net worth Accounting Quality – Past Financials Effectiveness of Projections – Future Financials 1. Interest Coverage International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 126

This ratio calculates the coverage for interest payable by the company from the cash generated from the operations. The unit for measurement of this ratio is times.

Interest Coverage = Profit before interest, depreciation and tax (PBDIT) / (Interest and Finance Charges)

(Interest coverage is considered only for the latest year.)

Interest coverage

Less than 0.5

0.5 to 1.02 to 1.55 to 2.36 to 3.02 to 5.17 to Above 10.16 1.02 1.55 2.36 3.02 5.17 10.16

Score

1

2

3

4

5

6

7

8

2. ROCE (Return on capital employed) The Return on Capital Employed (RoCE) is one of the most important parameters of profitability. It assesses the return on the “investment” made in the borrower’s business by the main stakeholders who provide capital - shareholders and lenders like banks or financial institutions. Ideally, the RoCE should be more than the weighted average cost of capital for the borrower. Only if it is more than the weighted average cost of capital, then the suppliers of capital can hope for adequate level of rewards from investing in the borrower’s business. If the RoCE is lower than the cost of capital, the business is not generating enough returns for the amount of capital invested. It represents an opportunity loss for the capital providers, as the business does not generate enough value for adequate returns. The unit for measurement of this ratio is percentage. ROCE = Profit before interest and tax (PBIT)/ Capital employed • •

Where capital employed = (Capital + Reserves + Short term debt + Long term debt +Deferred Tax Liability– Intangible Assets – Deferred Tax Asset - Miscellaneous Expenditure not written off- Accumulated LossesRevaluation reserves – Capital work in progress) ROCE is scored as a weighted average of the least three years. ROCE (%)

Less than

3.5% to 6.98% 6.98% to

International business school, Kolkata

Bank of Baroda

9.16% to

11.84% to

13.14% to

16.70% to

Above

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 127

3.5% Score

1

2

9.16%

11.84%

13.14%

16.70%

19.61%

19.61%

3

4

5

6

7

8

1. PAT / Net Sales The operating profit margin assesses the profitability of the main operations of the borrower, arising from the income from the main operations of the borrower. Non -operating income like investment income, prior period income and other extra ordinary income is not taken into account, as it is not a sustainable and stable source of income. The ratio indicates the market outlook for the borrower’s products and services which is translated into the sales price for the product / service and the “premium” that the borrower can command for a product or a service, depending on the borrower’s market leverage. The scale of the operations of the organisation, the level of competition existing in the industry and the relative position of the borrower’s organisation in the industry are some of the factors, which influence the market leverage. For example, soaps are basically commodity products, but branding can result in different sales pricing due to the positioning strategy adopted by a manufacturer and the market position of the manufacturer. The ratio is defined as PAT after Extraordinary & Prior period items / Net sales

PAT Net Sales (%)

/ Less than -5%

Score

1

-5% to -2.13% –2.13% to 0.24%

0.24% to 2.62

2.62% to 3.93%

3.93% to 7.19%

7.19% to 10.71%

Above 10.71%

2

4

5

6

7

8

3

2. Debt Service Coverage Ratio (DSCR) It is imperative to ascertain the safety of the debt facility or loan quantitatively in terms of the coverage of profits or cash flows for debt obligations like interest and debt repayment. Traditionally, the safety of debt facilities has been assessed on the basis of profitability, in terms of coverage of interest and debt repayments by the profits earned by the business. But this method does not capture the ability of the business to generate adequate or more than adequate cash flows for coverage of debt obligations. This means that though a business may be making adequate or more than adequate profits for debt coverage, the business may not be generating enough cash for servicing debt obligations. Such situations may arise when the working capital management of the business is not strong, or when a substantial amount of cash gets tied up in current assets. Therefore, to conservatively assess a business’s ability to meet debt obligations, cash flows generated from operations should be used instead of profits earned from the business. The cash flows generated from operations should not take into account inflows like non-operating income or extra-ordinary income or expenditure because such inflows are non-recurring in nature DSCR = (PAT after extraordinary & prior period items + depreciation + interest)/(interest + Current portion of long term debt) (DSCR is taken only for the latest year) International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 128

DSCR

Less than 0.4

0.4 to 0.63 to 0.89 to 1.27 to 1.52 to 2.6 to Above 4.25 0.63 0.89 1.27 1.52 2.6 4.25

Score

1

2

3

4

5

6

7

8

3. Total Outside Liabilities / Tangible Net worth This ratio is the most important parameter of solvency because it captures the capitalisation or the level of ‘gearing’ of the borrower. The level of gearing indicates the level of financial risk faced by the borrower on account of the level of debt employed by the firm. A high level of debt can lead to high gearing which is financially risky, as the borrower would have to service fixed obligations on the debt taken (in the form of interest or principal) irrespective of whether the business is making a profit or a loss. TOL / TNW = (Long term debt + Short term debt + Other current liabilities) / (Equity Capital + Preference Capital > 12 yrs + Share premium + Revaluation Reserves + General Reserves + Other Reserves & surplus - Intangible Assets Revaluation reserves)

(TOL/TNW is taken only for the latest year)

Total Debt Less / Tangible than Net worth 0.54

0.54 to 0.98 to 1.22 to 1.91 to 2.90 to 5.00 to Above 10.00 0.98 1.22 1.91 2.90 5.00 10.00

Score

7

8

6

5

4

3

2

1

4. Net cash accruals / Total debt This parameter measures Cash Flow adequacy. (PAT after Extraordinary & Prior period items + Depreciation + Pre expenses w/off - equity dividend - preference dividend)/ (Short Term Debt + Long Term Debt)

Net cash Less accruals / than Total debt 0.04

0.04 to 0.06 to 0.07 to 0.09 to 0.11 to 0.26 to Above 0.47 0.06 0.07 0.09 0.11 0.26 0.47

Score

2

1

3

International business school, Kolkata

Bank of Baroda

4

5

6

7

8

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 129

5. Current Ratio The current ratio is an important measure of liquidity as it measures a borrower’s ability to meet short-term obligations. It compares short-term obligations (or current liabilities) to short term (or current resources) available to meet these obligations. A lot of insight can be obtained about the immediate cash solvency of the borrower and the borrower’s ability to remain solvent in the event of adversity, by measuring the current ratio. Current assets mainly comprise inventories, receivables (also called debtors) and other items like cash and bank balances, loans and advances to other organisations / borrower’s affiliates etc. Current liabilities mainly comprise bank borrowings, payables (or creditors) and other liabilities like security deposits; payments accrued to government agencies etc. Generally, a high current ratio indicates a high level of liquidity for the borrower. Banks in India have fixed a benchmark of 1.33 times for an indicative current ratio, based on the Tandon Committee Recommendations. Current Ratio = (Total Current Assets - Debtors > 6 months – Loans & Advances to group concerns) / (Total Current Liabilities & Provisions + Preference Capital payable in the next year + Secured & Unsecured loans payable in the next year) (Current ratio is calculated only for the latest year.) Current Ratio

Below 0.38

0.38 to 0.78 to 0.92 to 1.07 to 1.14 to 1.36 to Above 1.56 0.78 0.92 1.07 1.14 1.36 1.56

Score

1

2

3

4

5

6

7

8

6. Net worth Net worth = Equity Capital + Preference Capital > 12 yrs + Share premium + Revaluation Reserves + General Reserves + Other Reserves & surplus - Intangible Assets - Revaluation reserves. Net Worth

Less than 150

150 300

Score

1

2

to 300 450

to 450 700

3

to 700 900

4

to 900 to 2020 to >13410 13410 2020

5

6

7

8

7. Accounting Quality Accounting Quality measures the quality of financial statements. Poor financial accounting practices will result in inflated results. Descriptive Text

Average

Excellent

Good

Poor

Equivalent Value

0.95

1.01

1.00

0.90

International business school, Kolkata

Bank of Baroda

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 130

8. Contingent Liabilities – Past Financials The factor acts as a deflator to deflate the overall score by 0, 10 or 20 percent based on the selection. Descriptive Text

HIGH IMPACT

MEDIUM IMPACT

NO / LOW IMPACT

Equivalent Value

0.8

0.9

1.0

9. Management of foreign exchange and fund repatriation risk – Past Financials Management of foreign exchange and fund repatriation risks - must be scored only if exports exceed 40 % of sales. Sound management practices can to a large extent contain the effects of foreign exchange fluctuations and repatriation risks. This parameter has to be assessed on the basis of presence of forex risks and the efforts to hedge these risks effectively. Marks

Attributes

10 8

Subjected to very high forex risk, which is not hedged. There is no focus on hedging the risk. Subject to significant forex risks that might be unhedged.

6

Subjected to some unhedged forex risks.

4

Subjected to some forex risks but hedging used to mitigate any substantial effects.

2

Not subjected to any significant forex risks. Hedging issued to protect from risks related to forex fluctuations.

0

Not subjected to any forex risk. Any such risks are totally hedged.

10. Effectiveness of Projections – Future Financials Descriptive Text

Very rosy unreasonable

Equivalent Value

0.60

International business school, Kolkata

Bank of Baroda

& Optimistic extent 0.80

to

some Reasonable acceptable 1.00

&

ASSESSMENT OF SEGMENTED RISKS AND CREDIT WORTHINESS UNDER BOBRAM MODEL. (BOB, KOLKATA DOMAIN) 131

FINANCIAL FLEXIBILITY Financial Flexibility attempts to evaluate the ability of a company to comfortably raise funds to meet its future requirements (both planned as well as unplanned). The company is evaluated on the basis of its ability to raise the required funds either via debt or via equity route. The qualitative parameters considered are: Ability to Raise Debt  Ability to raise debt from Banks / Financial Institutions  Ability to raise debt from market Scoring to be based on (a) L T Debt: Equity (b) TOL: TNW (c) No of banks dealing with (d) Investments in Liquid Assets of the company (e) Whether the company has raised debt from the Market in the past or not (f) Company's external credit rating, if available (g) Market reputation of the company Ability to Raise Equity  Ability to raise equity from own sources  Ability to raise equity from Capital Market Subjective scoring based on (a) Personal wealth of Promoters (b) Commitment of the Promoters to the company (c) Financial strength of group companies (TOL/TNW, Current Ratio and other ratios) (d) Any instances in the past when the group companies have bailed out any ailing company in the group.

International business school, Kolkata

Bank of Baroda